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Volume XI
| Issue I | Fall 2017
A student-run journal from
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From the Editor Dear Reader, Thank you for reading the Fall 2017 edition of the Virginia Policy Review. We at the journal strive to publish work that will impact the wider policy debate. Our mission is to do this through a variety of journalistic mediums, including research articles, opinion pieces, interviews, and book reviews. Charlottesville and this nation are looking closely at what we as a society stand for. Public policy is more important than ever for rational discussion and fact-based solutions. We at VPR are excited to bring you articles that meet these criteria. This issue covers a range of policy issues from and represents submissions from across the country. This includes pieces on American democracy, Chinese local government, the ethics of emissions trading, and a host of other works. I am delighted to begin my tenure at Virginia Policy Review for the 2017-2018 term. We are looking forward to our sixth National Journal Conference this coming April and continuing our relationships with other policy schools across the country. We hope you enjoy this edition of VPR and consider submitting to a future iteration, with instructions for submission on our website: www.virginiapolicyreview.org Warmest regards, Dylan Kolb Editor-in-Chief
Staff Acknowledgements Editor-in-Chief:
Dylan Kolb
Content Director:
Casey Boyette
Executive Editor:
Anna Troutman
Managing Director:
Lianne Provenzano
Senior Editors:
West Connors Carly Gorelick Olivia Roat Anne Lukehart Phillip Menard Avery Moyler
Associate Editors: Brian Kim James Leckie Ellie Beahm Joshua Margulies Jack Dimatteo
Maia Rosewelsh Ruhama Yared Caroline Snead Grace Erard
We welcome your thoughts. Please forward any comments, questions, or concerns to virginiapolicyreview@gmail.com or visit us online at http://www.virginiapolicyreview.org/.
Table of Contents
I. The Trump Administration, Anxious Allies, and the
Guardrails of Democracy By Gerald Warburg ............................................................ 1 II. Analysis of the Ethical Limitations of an Emissions
Trading System Adopting the Views of Peter Singer By Jongeun You ................................................................ 14 III. U.S. Democracy Promotion in Egypt Under the Trump
Administration By Phillip Menard ............................................................ 21 IV. Does Socioeconomic Inequality Undermine Local
Government Credibility in China? Evidence from China Family Panel Studies (CFPS) By Jingyuan Qian ............................................................. 45 V. The Community Reinvestment Act at 40: A Careful
Review of the Reviews By Josh Silver ................................................................... 75 VI. Key Stakeholders Explain the Difference Between M-
Pesa’s Success in Kenya and Failure in South Africa By Karl M.F. Lockhart ..................................................... 87
VII. Enhancing U.S. Power through Sound Financial
Regulation: How Wall Street Reforms Can Defend American Hegemony By George E. Rudebusch ................................................ 100 VIII. Lives and Livelihoods: The Economic Impact of Ebola in
West Africa By Joniel Cha ................................................................. 124
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The Trump Administration, Anxious Allies, and the Guardrails of Democracy By Gerald Warburg
“The past is never dead. It’s not even past.” — William Faulkner, Requiem for a Nun How do the institutions of democracy contain the excesses of a controversial American president? This was the question put to me repeatedly this fall by allied diplomats from France, England, and Germany. “Your president is like a car careening down the highway with no brakes,” lamented a Foreign Ministry official in Paris. “President Trump calls NATO ‘obsolete,’ denies climate change, and trashes trade accords. Where are the guardrails to contain him?” It is an important question—whether one supports or resists the disruptive course set by the Trump Administration in its first year. The subject is an especially difficult one for U.S. allies in Europe, as I found on a recent lecture tour. For three generations American allies have looked to Washington for military, economic, and moral leadership to advance democratic values. Now, as German Chancellor Angela Merkel acidly commented earlier this year, they feel alone. What strikes one first is the profound irony. At a time when American policymakers have stepped back from a global leadership role, much of the responsibility to advance common goals has fallen to Europeans. Specifically, much of this work has been take up by Angela Merkel, the embattled German leader educated under the communist system; an Argentine priest in Rome, Pope Francis; and Emmanuel Macron, a French banker and ‘radical centrist’ who rejects unilateralism. These leaders of church and state are
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championing democratic values at a time when hyper-polarization in the United States has weakened Washington’s ability to lead.
Key Questions Anxious allies press three key questions: does the Trump transformation represent an irreversible change in America’s role in the world? Second, what are the restraints placed by Congress and other democratic institutions upon Trump’s initiatives—how might American institutions work with him on some long overdue reforms but resist his many excesses? Third, how will the evolution of the two political parties in Congress impact American security and trade policies? First, has the Trump Administration made irreversible changes in the American role in the world? Yes, and no. Yes, Donald Trump is the first president since Calvin Coolidge in the 1920s to reject an American leadership role in multilateral negotiations, military aid, and foreign assistance. Many citizens grieve for the resulting forfeiture of the moral high ground to which Americans aspire in confronting international challenges. But, no, little of what happened on both foreign and domestic policy in the first twelve months after Trump was elected is irreversible. On two international fronts, his election represents a clean break with the past. America is now an unmistakably protectionist nation. Free trade pacts seem very last century; some of their strongest champions among Senate Republicans are retiring from the field or muting their voices. Nine straight years of economic recovery have still left too many American workers behind. The pro-union BernieSanders left has joined with the Rand-Paul anti-immigration right to blame free trade deals for the economic dislocation wrought by automation and globalization. The American demand that European and East Asian democracies do more to defend themselves has
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similarly become mainstream policy. Pressing NATO governments to increase their defense spending to 2 percent of GDP was, in fact, an Obama Administration policy initiative. It is now a central Trump tenet, riding atop a host of White House grievances against both allies, like Mexico and Canada, and adversaries, like China and Iran, who are said by “America First” champions to have somehow out-negotiated every past American president. Beyond these two planks, which elements of the Trump international policy departures are here to stay? His abandonment of human rights and multilateralism? His embrace of authoritarian dictators? On these positions, Trump remains an outlier in Washington—and with U.S. voters. Indeed, as a man not anchored to any political philosophy or party, Donald Trump has been challenged by Republicans on his scorn for human rights and multilateral accords. Looking just at the pushback from Republican leaders such as John McCain and Bob Corker, and weighing the results of President Trump’s recent Asia trip, there seem to be many points of continuity in U.S. policy, and fewer of transformation. This is true on U.S. policy towards China, Japan, South Korea, NATO, Iraq, Afghanistan, Africa, and ISIS. By tying the president’s hands with renewed sanctions against Russia and cooperating with Special Counsel Mueller’s investigation of the Trump-Russia communications, Congress has even limited President Trump’s options with Moscow. Notably, Congress passed the GOP-sponsored anti-Putin sanctions legislation in June without including a presidential waiver. This unprecedented development serves as a measure of the distrust with which many in the Republican Establishment view Donald Trump. Other allies face more existential threats than Washington—the sun-setting ‘United’ Kingdom with Brexit and a looming Scottish vote on independence; France with labor, economic growth, and assimilation; Spain with secessionists in Catalonia; Israel with
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Iran’s ballistic missiles and support for terrorist groups; and both Japan and South Korea with the grave nuclear threats from North Korea. The current challenges eroding U.S. democratic institutions—including the vulgarization of our politics by an administration that deliberately seeks political advantage from dividing the nation into opposing camps, and by a Russian regime aggressively polluting our elections with hackers and Facebook trolls—is not, yet, so grave.
Restraints of Democracy How significant are the restraints placed by Congress and other democratic institutions upon Trump’s initiatives? Again, whether one is thrilled or appalled by the Trump agenda, it has become clear that even the most battered American institutions are providing some checks to the more extreme Trump positions. In this respect, they are serving as the ‘guardrails’ for a system of shared powers as our Founders intended. Throughout the history of the United States, generation after generation, excess begets reform. The raw capitalism and labor abuses of the early 20th century met a wave of progressive reforms under Republican President Teddy Roosevelt. Franklin Roosevelt’s overreach in seeking to ‘pack’ the Supreme Court was blocked and his freelancing foreign policymaking practices ultimately reined in by creation of the National Security Council (NSC). The brilliant Richard Nixon won a 49-state mandate in 1972, yet his criminal abuse of presidential powers was halted by impeachment less than 24 months later—with a delegation led by conservative icon Barry Goldwater from Nixon’s own party ultimately showing the President the door. The Bush-Cheney excesses, from Iraq to deregulation to extra-Constitutional signing statements, were limited over time by a resurgent Congress. And the endless stream of executive orders that characterized the second term of the former
Virginia Policy Review Constitutional law professor Barack Obama have systematically reversed by the Trump Administration.
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The founding principle of our democracy was a deep suspicion of concentrated power. So, the appeal of a dishonest strongman remains limited, even in a divided nation that seems, at times, to consist of fifty bright blue cities within fifty otherwise deeply red states. As an optimist, I believe the so-called ‘guardrails’ of democracy remain vigorous and are manifest each day. Yet, I came of age in suburban California during the “Wonder Years” of President Jack Kennedy. We were taught that our civic institutions—Congress, the courts, the White House, the CIA and FBI, public universities, the two-party system, mainstream media, Main Street and Wall Street, and our armed forces—were infallible. These institutions have suffered in the decades since. Their decline in the public esteem began with the Vietnam War and Lyndon Johnson’s credibility gap. It continued with the impeachment of Richard Nixon, then the scandals of the Bill Clinton years. These institutions were further undermined by the Bush-Cheney invasion, on spurious grounds, of Iraq. Donald Trump’s tweets and falsehoods have assaulted these very same institutions, beginning with the free press. Mainstream and alternative media have pushed back, even as their editorial views have contaminated their coverage. The New York Times and Washington Post are thriving, with hundreds of thousands of new online customers. American courts have stood up to the president, checking him repeatedly, as on immigration and the “Muslim ban.” However, Congress—the ‘first branch’ afforded great powers under our Constitution—has not yet found its spine and institutional voice. Democrats initially voted in large number for the disastrous Iraq war. Through a series of authorizations of subsequent military
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actions, Congress failed to uphold the legal requirements of the War Powers Act. Over many years of obstructionism against Barack Obama, Congress ceded far too much power to the executive, from war and peace decisions to the implementation of health care and immigration policies by executive order. In the first twelve months after Election Day 2016, however, the GOP-led Congress failed to enact any of the Trump Administration’s signature legislative proposals. They rejected Trump’s 2,000-mile border wall, his massive cuts in foreign aid, and his insistence on the repeal and replacement of the Affordable Care Act. Special Counsel Robert Mueller’s work looking into alleged malfeasance by Trump campaign and administration officials is advancing, with recent indictments of Trump’s campaign chairman, Paul Manafort, and two campaign staffers combined with the guilty plea entered by Trump national security advisor Michael Flynn. Never before has a first-year president faced separate investigations by both a House and Senate controlled by his own party, and by a Special Counsel. Trump continues to have a nearly free hand in nullifying many of President Obama’s executive orders, especially on environmental protection, health care, and immigration. But the courts are challenging these Trump reversals. Many are likely to—again—be reversed after his time in the White House passes. The nation will lose time—which is particularly painful for climate change activists, especially when one considers the devastation wrought this past hurricane season in Florida, Puerto Rico, and Texas. Americans do not govern by ‘ordinance,’ as the French and President Macron are trying to do with labor law reforms. Executive orders from the White House should not be mistaken for long-term American policy reversals; they are rarely sustainable without enactment of legislation with bipartisan buy-in. Critics find some comfort in the three generals at the forefront of Trump security policymaking—the few White House aides who
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refuse to play the role of Cabinet Room sycophants. His second Chief of Staff, General Kelly; his second NSC head, General McMaster; and his thoughtful Secretary of Defense, General Mattis appear to push him often towards more mainstream positions advancing U.S. national interests. They have differed with him publicly on issues from the value of the multilateral accord, to the containment of Iran’s nuclear program, to the wisdom of engaging North Korea. And in interagency consultations, even Trump’s own cabinet picks have lamented his disdain for facts and information, as when the Secretary of State Rex Tillerson and NSA McMaster recently belittled the President Trump’s intelligence. Allies are having a very difficult time navigating such troubled waters. The resulting isolation of Washington from long-standing friends ill serves the national interest. As Secretary Mattis put it bluntly in September: “Nations with allies thrive, and those without allies decline…We must be willing to be persuaded by them…not all good ideas come from the nation with the most aircraft carriers.” In this sense, the American government and U.S. voters—even amidst extreme polarization—are also experiencing some convergence. The more Donald Trump bashes the independent press, the FBI, and the intelligence community, the more value the American center sees in these institutions. He may still maintain climate change is a hoax, but most mayors of major American cities—from New York to Norfolk, from Miami and Houston to San Francisco—are already at work ameliorating the dangers that rising seas and intensifying super-storms present now to lives and infrastructure. Republicans in Washington have abandoned their long-held opposition to deficit spending. At this writing, Congress is completing a measure to slash corporate taxes, a move that could increase deficits up to $1.5 trillion. Many fear Washington’s embrace of another round of supply-side economics—despite the
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fact that the Reagan and Bush tax cuts increased economic inequality, while ballooning the U.S. deficit and indebtedness to China. Trump remains a transformative figure, albeit one who cheapened American politics. It is not just his coarse words for friend and foe alike; it is the very idea that the Big Lie works, that falsehoods repeated can be made to stick with one’s political base, even if it is only 35 percent of the populace. He is susceptible to the fawning flattery of dictators. And he returns the over-the-top embrace when authoritarian regimes in Manila and Saudi Arabia roll out the red carpet. He has been remarkably blind to Russian manipulation and the criminal actions of the Putin regime, a blindness that separates Trump from all post-World War II U.S. presidents. He further poisons civil dialogue with his glee in bullying and his false moral equivalence between white supremacists and those racists who resist the neo-Nazi KKK. And his juvenile actions—such as the ‘Rocket Man’ line at the United Nations or retweeting fringe group appeals—can inflame fraught situations. That is why some Republican leaders (and even British Prime Minster May) have called him out for comments that harm U.S. national interests. Just look at the reaction of the adults in the room when he utters these blasts: the latest Chief of Staff, General Kelly, has been seen staring at his shoes in apparent disgust. The effect has been to unify Democrats in opposition, to appall millennials—who voted overwhelmingly against Trump—and to split the GOP. One of the most closely followed stories in Washington recently has been the civil war in the nation’s oldest political party, the Republican Party of Lincoln and Eisenhower. Trump’s taunting tweets are often directed at the same centrist Republican senators whom he needs to pass any significant legislation—Corker, Flake and Heller…McCain, Murkowski, Alexander and Collins. He humiliated members of his allRepublican cabinet in front of Democratic Party leaders. His ally
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Steve Bannon continues to make war on GOP centrists from his “Fort Breitbart” on Capitol Hill. Because Trump is not moored to any core political principles, he is ready to bargain with others when he is hungry for a ‘win,’ as was seen this September when he dealt with Democrats on debt and on immigration Trump’s politics of disruption do offer new possibilities. Trump was elected in part by angry voters who felt left behind by coastal elites and inside-the-Beltway dealmakers. Scores of Trump voters I interviewed last summer during a tour through Appalachia and the Deep South believe that a vote for Trump was, as one Alabama waitress told me, “the only way I had to give the Washington crowd the finger.” Trump’s ideological flexibility offers possibilities for consensus deals: What if the U.S. agreed to work with allies to strengthen the Iran nuclear deal, adding sanctions on Tehran’s ballistic missile tests and aid to terrorist groups? What if centrists refused to use the health care fears of U.S. citizens as a political football, but instead advanced a bipartisan proposal to stabilize markets? What if U.S. leaders sought to build on the Paris climate deal, instead of isolating Americans with a policy of science denial? The Presidency and the ‘Deep State’ One of the significant pieces of the guardrails thus far containing Trump at times appears to be the entrenched federal bureaucracy. Trump’s justifiable fear of the “deep state,” the inherited civil service of Washington centrists invested in the status quo, has had deleterious effects. Don’t doubt him here—there is a deep state, as Nixon used to lament in distrusting the State Department. One foreign policy example: When Trump wanted to change Obama’s Cuba policy, every single cabinet agency consulted resisted. He came out last June with much-compromised mush that keeps a number of the Obama-era changes. Federal agencies staffed by
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career civil servants hostile to his agenda continue to leak information critical of his policies. The Trump impact on one key agency is instructive. The incoming Trump NSC team availed themselves of little that the Obama transition offered. They were explicitly warned that the North Korea file was the toughest; both Democratic and Republican predecessors found no easy answers. But Michael Flynn purged all the Obama holdovers; then he pushed out all the career civil servants detailed to the NSC. The early Trump NSC was therefore staffed by some real extremists and ‘third-string’ players, while led by a man who has since pleaded guilty to a felony. By contrast, General McMaster is highly respected. He brought in more sober thinkers, while purging several of Flynn’s appointees. Yet, McMaster has leaned on many career military officers; his staff is said at times to resemble CENTCOM more than a balanced interagency arbiter. There is a shortage of regional specialists and intelligence community veterans. The dangers, as wise generals lament, is that “if all you have is a hammer, every problem looks like a nail.” And the gutting of the State Department and the retirements of so many Foreign Service Officers is ominous. Amidst the crisis with North Korea, the Trump Administration has no Assistant Secretary for Asia and, beyond an Iowa governor he sent to Beijing as a political payoff, not a single ambassador he has appointed to any country in the region.
The State of U.S. Political Parties What is the state of the American political parties and how will their evolution impact allies in Europe and Asia? Here again the split in the Republican Party is a key indicator. Leaders Paul Ryan and Mitch McConnell are intelligent, calculating survivors. From 2010-2017, their commitment to all-out party-line obstruction succeeded as an electoral strategy. It failed, however, as a
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governance strategy. Republicans’ governing muscles were rarely exercised. Even after controlling all three branches of the federal government, they did not enact a single major legislative initiative in their first eleven months of one-party rule—and what promises to be their first legislative success, giving tax breaks to corporations while adding to the national debt, has a relatively low degree of difficulty. By contrast, George W. Bush had, at the same point in his presidency, enacted major education, tax, and security reforms. Barack Obama had enacted a major stimulus package, health care reform, and re-regulation of Wall Street. Democrats have taken heart in recent voter turnout in off-year elections in Virginia and New Jersey. Yet, national Democratic Party figures have offered few new ideas. They risk becoming the anti-Trump party. They lack a deep bench of young national leaders. In 2016, Hillary Clinton ran, in many respects, as a status quo candidate who failed to articulate a clear economic growth plan. When the “fresh young faces” in a party who are advanced as alternatives (Biden and Sanders) are two career politicians in their 70s, that party has serious succession challenges. And the politics of grievance mastered by Trump forces are not new. They have been a part of the identity politics used by many Democratic activists for decades. They were manifest in the failed George McGovern presidential campaign of 1972, and they continued through the Michael Dukakis campaign of 1988, through Howard Dean, and up to the present with Bernie Sanders.
The 1930s Redux? The darkest lament I heard in Europe was this: “It feels like 1938.” The parallels are striking. Struggling young democracies in the interwar years failed to describe a common vision to overcome stagnant economies. Forces of modernization disrupted labor markets, but centrist politicians failed to emerge and chart a path to
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economic security. Thus, democratic governments failed to provide people the tools to adapt to change, to retrain workers, and to address factional challenges. In 1938, as at present, populists railed against foreign trade and past agreements. Politicians preached protectionism without describing a compelling vision for the future. Today, Spain has warring factions in Madrid and Barcelona adding to add to the ominous echo of the 1930s. As William Faulkner warned, sometimes the past is not dead—and it is not even past. Or, as a French interlocutor lamented to me, a society that can only talk about the past surely lacks a vision for the future. In the 1930s, nationalist leaders arose in Europe and Japan, successfully pitting faction against faction, tribe against tribe. This was the heyday of the politics of grievance in the face of complexity; then (like now) blame was placed on Others—bankers and trade financiers, foreigners, and immigrants. Demagogues mastered the Big Lie and exploited new media propaganda techniques to obscure essential truths. They assaulted vulnerable civic institutions, from popularly elected legislatures to the press to independent courts, and the very legitimacy of free elections. In the 1930s, vulnerable democracies were replaced by dictatorships based on cults of personality. It ended very badly. Some of the grim European analysts I heard from still maintain hope that the guardrails of American democracy can contain the passions of populism. Even when they don’t care for our elected leaders, European allies retain hope that shared values unite us. It is important to stress what we still have in common. The United States remains an immature nation. When we engage the Chinese, the Persians, the British, and the French, we often show our impatience and impulsivity. We must not let that character flaw obscure the values that a majority of Americans share with allies. Americans still revere individual liberty. We uphold the dignity and rights of fellow humans. We aspire to pluralism and just government. Our defenses are intended not to invade and conquer,
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but to protect the peace. We still seek allies who share our democratic principles; we remain critical of the authoritarian leaders. We used to welcome refugees and the oppressed, drawn as they are by our reverence for freedom of worship and a free press. We struggle, often ineffectively, with economic inequality. Yet we press for equality of opportunity, not of result. We believe leaders should maintain a social safety net for those in dire need, consistent with our many different faiths. And finally, one hopes, that despite the rhetoric about defending national sovereignty, we maintain enough humility to resolve to uphold what Thomas Jefferson committed us to in our founding Declaration of Independence, “a decent respect for the opinion of mankind.� Gerry Warburg teaches at the University of Virginia’s Frank Batten School of Leadership and Public Policy. He served for many years as an advisor on foreign policy, defense and intelligence matters to leadership of the U.S Senate and House of Representatives. He is the author of a number of works on U.S. foreign policymaking, nuclear nonproliferation, and the struggle between Congress and the President to shape U.S. international policy.
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Analysis of the Ethical Limitations of an Emissions Trading System Adopting the Views of Peter Singer By Jongeun You
A number of governments are implementing market-based policies to reduce emissions of greenhouse gases (GHG). In this commentary, following to some extent the views of Peter Singer, I will focus on the emissions trading system (ETS), which is one of the most effective options for dealing with climate change. I argue that the core tenets of the proposal are justifiable for both economic and ethical reasons concerning the values of liberty and fairness. At the same time, however, I partially disagree with Singer concerning how emission rights should be allocated. Basing allocations on population alone does not recognize developed countries’ historical responsibility for climate change and is therefore unjust. The system should incorporate an additional fund for developing countries.
Definition of ETS An ETS is a market-based approach for tackling GHG linked to climate change. The main form of ETS is known as cap-and-trade: a cap on emissions is set by the government and then permits are created up to the level of this cap. The companies or other entities covered by the scheme need to hold one permit for every ton of pollution they emit. Allowing trade in these permits puts a price on pollution – for example, the cost of emitting one ton of carbon dioxide is the cost of the permit – and incentivizes companies to reduce pollution in order to avoid penalties if they exceed the cap or sell allowances to other companies that emit more.
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Basing allocations on population can be beneficial for liberty and fairness The last decade has witnessed the development of various ways to cap emissions. For instance, Australian moral philosopher Peter Singer (2007) proposed a method of allocating emissions for auction based on population. This method emphasizes values such as liberty and fairness. Following the harm principle, which states that “the only purpose for which power can be rightfully exercised over any member of a civilized community, against his will, is to prevent harm to others” (Mill, 1874), governments can exercise their power over companies in order to limit the harmful consequences of companies’ GHG emissions. Population-based emissions allocation is an approach that recognizes the need to curb emissions, while preserving economic liberty to the largest degree compared to the alternatives. It is done by providing flexibility for individual companies to achieve GHG reductions in their preferred ways. Calculating emissions caps by population is easier than considering other complex dimensions, like historical emissions using a baseline year’s emissions (Pew Center, 2008), or the average of the past years’ energy consumption, or by level of production in the current period (California Economic and Allocation Advisory Committee, 2010). Allowance on the basis of population is a valid tool for providing a predictable emissions pathway, which can help businesses in decision making as well as estimating the emissions cap they would have impacted. An entity can fulfill its reduction obligations by achieving its own emissions reductions or by purchasing surplus emissions credits from other companies. This tool promotes liberty along with high public acceptability and political feasibility. In addition, establishing emissions limits that are proportional to population emphasizes fairness, because it is predicated on the principle that each person deserves access to an equal portion of the
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atmosphere's capacity to absorb our GHG emissions, thus denying that anyone has a greater entitlement than others. Since the absorptive capacity of the atmosphere is a common good and a global resource, humanity as a whole is entitled to impose charges on using it (Caney, 2010). Once we view society as a system of cooperation that benefits everyone, the rules we accept in our common lives will affect how the benefits of social cooperation are distributed. We ought to favor rules that distribute those benefits fairly. When the global community has to limit the use of the atmosphere to sustain life, it should take into account the interests of each person who has an equal right to use the commons. This approach has pitfalls from the point of view of “historical responsibility” and “right to develop” From the perspective of justice, adopting only population as a means to calculate allocations could be problematic. Allocating by population would impose extremely high mitigation demands on many developing countries, which bear little responsibility for contributing to climate change in the past. Less developed countries aren’t in the “appropriate initial status quo” (Rawls, 1999) as developed countries are. For example, developed countries have emitted disproportionately more than developing countries, but their current population does not acknowledge developed countries’ past contributions to climate change. In 2012, the top 10 GHG-emitting nations contributed 72 percent of global emissions, while China, India, Brazil, and Indonesia contributed 36 percent of global GHG emissions (World Resources Institute, 2015). Those four countries claim that they have the right to develop and require more allocations than what would be allocated to them using the population method. These countries argue that they are in an early stage of the economic development process relying on fuel and technology, which create GHG. By comparison, they claim, developed countries have already passed through this stage and therefore do not need to emit GHG at the
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same rate. As an example, India argues that there is a difference between “survival” emissions occurring in the developing world, which are critical to survival, and “lifestyle” emissions resulting from the affluent lifestyles of the developed world (Saran, 2008). They do not belong to the same category and cannot be treated with the same weight. Furthermore, no matter the current size of each developing country’s population, allocating equal allowances to all individuals could be unfair, due to existing significant differences in their levels of economic development. Those who advocate for population-based allocations argue that considering past emissions rather than present or future emissions would hamper the motivations of developing countries to develop industry and technology designed to curb emissions. Moreover, since developing countries now have a better understanding of the causes and effects of climate change, compared to developed countries which for much of their development history operated without clear knowledge of climate change, developing countries also have a responsibility to reduce further GHG emissions. Finally, advocates for population-based allocations argue that, in the case where a developing country demands a higher quota, they could secure credits through trading in the market after the initial allocation. In reality, however, fair competition (e.g. technical competition, trading) in an uneven playing field is impossible. Developed countries have more resources to be better able to reduce their GHG emissions and have already constructed an eco-friendlier economic structure. Recommendation Despite the current existence of national and regional ETSs that are increasingly linked to one another in order to benefit from cheaper carbon reduction opportunities (U.K. Energy and Climate Change
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Committee, 2015), a global ETS that covers both developed countries and developing countries has a long way to go. At the Paris climate conference (COP21) in 2015, countries stopped at the level of reconfirming the importance of international carbon markets and common robust carbon accounting rules. To facilitate the timely development of a global ETS that could cap overall emissions at a safe level, I support emissions caps proportional to population. To address the shortcomings deriving from the “historical responsibility” and “right to develop” arguments, I recommend that the global community implement an ETS fund, comprised of donations from developed countries, that is dependent upon their current wealth as determined by GDP size. Through the ETS fund, the payments would flow to developing countries as a form of compensation for developed countries’ past contributions to climate change. Then, developing countries could use the funding to address climate change and develop green technologies. Employing the ETS fund to implement a worldwide ETS market seems politically feasible. Developed countries have already recognized and acknowledged their responsibility and have announced a number of financial pledges and green initiatives, such as Green Climate Fund founded in 2010, aiming to raise $100 billion a year by 2020. What’s left to do is to clearly specify that the funds provided to the developing countries as a means of an ETS fund. Now it is time for action. We should not pass the climate change problem to the next generation. Jongeun You is a second year MPP student at the Gerald R. Ford School of Public Policy at the University of Michigan. He is working as a Policy Analyst at U-M’s Center for Local, State, and Urban Policy, as well as assisting with research for U-M’s Policies for Action Research Hub.
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References California Economic and Allocation Advisory Committee. (2010). Allocating Emissions Allowances Under a California Cap-and-Trade Program, 17. Caney, S. (2010). Markets, morality and climate change: What, if anything, is wrong with emissions trading? New Political Economy, 15, 205. Mill, J. Stuart. (1874). On liberty. 5th ed. London: Longmans, Green, Reader, and Dyer, 13. Pew Center. (2008). Congressional Policy Brief: Greenhouse Gas Emissions Allowance Allocation, 4. Rawls, J. (1999). A theory of justice. Rev. ed. Cambridge, Mass.: Belknap Press of Harvard University Press, 12. Saran, S. (April 21, 2008). Talk by Special Envoy of Prime Minister, Shri Shyam Saran in Mumbai on Climate Change. Retrieved from: http://www.mea.gov.in/infocusarticle.htm?18821/Talk+by+Special+Envoy+of+Prime+ Minister+Shri+Shyam+Saran+in+Mumbai+on+Climate+ Change Singer, P. (2007). Commentary: A Fair Deal on Climate Change. Project Syndicate. U.K. Energy and Climate Change Committee (March 12, 2015). Fuelling the debate: Committee successes and future challenges. House of Commons. 16.
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World Resources Institute (June 23, 2015). Global Top 10 Greenhouse Gas Emitters. Retrieved from: http://www.wri.org/blog/2015/06/infographic-what-doyour-countrys-emissions-look.
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U.S. Democracy Promotion in Egypt Under the Trump Administration By Phillip Menard
Introduction Historical Background on U.S. Foreign Aid to Egypt Since the 1979 Egypt-Israel Peace Treaty, the U.S. has significantly increased its foreign assistance to Egypt, averaging about $1.5 billion annually, of which $1.3 billion is allocated to military assistance (Snider & Faris, 2011). However, it wasn’t until the 1990s, when the U.S. Agency for International Development (USAID), the federal agency which is primarily responsible for administering foreign aid, began to integrate democracy-focused assistance into its traditional program, that the U.S. started to use funds to support democracy in Egypt (Snider & Faris, 2011). Following the terrorist attacks of September 11, 2001, U.S. democracy promotion became a national security priority for the first time, and people began to see democratic aid as a critical tool for combating terrorism (Snider & Faris, 2011). Traditionally, the U.S. has provided foreign aid to the Egyptian government with few, if any, restrictions. However, in 2004, Congress passed an amendment that gave USAID’s mission in Cairo full control over funds allocated for democracy in Egypt in order to ensure transparency and accountability (Snider & Faris, 2011). Since 2006, the U.S. Government has been criticized by Egyptian citizens, non-governmental organizations (NGOs), and advocacy groups for its willingness to ‘ignore’ and tone down its rhetoric criticizing human rights violations committed by the Egyptian government in order to secure the stability of the U.S.-Egyptian relationship (Snider & Faris, 2011). In May 2011, the Obama
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Administration announced its intention to support the democratic transitions of governments in the Middle East, following the nascence of the Arab Spring. President Obama promised to dismiss debts of up to one billion U.S. dollars and guarantee up to the same amount in loans to support financial stability and workforce development in Middle Eastern countries (Snider & Faris, 2011). In 2013, the U.S. began to take a somewhat serious stance against the repressive Egyptian government after Mohammed Morsi, the democratically elected president, was ousted in a military coup led by General Abdel Fattah el-Sisi in July. On October 9, 2013, the U.S. Government suspended a significant amount of military assistance to Egypt, following the Egyptian military’s repressive crackdown on the Muslim Brotherhood (Labott, 2013). The U.S. suspended this assistance to encourage the military to move toward restoring democracy within the country. The U.S. Government chose not to classify the military takeover as a coup because that classification would have required them to cut all foreign assistance, except humanitarian aid, to Egypt (Labott, 2013). However, this suspension was short-lived. In March 2015, the U.S. Government restored its 1.3 billion U.S. dollar military aid package to Egypt to advance the countries’ coordinated military campaign against the Islamic State of Iraq and the Levant (ISIS), a militant group that aims to establish a Caliphate in Muslim-majority countries around the world (Ackerman, 2015). This concession is consistent with the historical support by the U.S. for authoritarian Egyptian leaders who undermine the democratization of Egypt but support U.S national interests in the Middle East (Mahmood, 2015). The Trump Administration has articulated its support for the current Egyptian government led by President Sisi, but key stakeholders, such as NGOs, advocacy groups, and Egyptian citizens, have put steady pressure on the U.S. to aggressively denounce the repressive Egyptian government and push for the democratization of Egypt.
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Should the U.S. Promote Democracy Abroad? Arguments for U.S. Democracy Promotion The two primary reasons for U.S. democracy promotion abroad are: 1) to secure economic benefits, and 2) to protect U.S. national security interests. Economic Benefits According to a 2007 Congressional Research Service report, U.S. democracy promotion can create free markets that offer economic opportunities and reliable trading partners overseas (Epstein, Serafino, & Miko, 2007). Research studies have found that countries transitioning into democracies are more likely to establish free markets, which often generate economic benefits and reduce the poverty and unemployment rates of the transitioning country (Griswold, 2006). Reducing the poverty and unemployment rates in these countries can lead to a reduction in internal conflict and instability, ensuring that the U.S. has reliable trading partners that are willing to import American goods and services (Stewart, 2002). One of the most famous examples of democracy promotion abroad that led to significant economic benefits for the U.S. is the Marshall Plan. After World War II, the U.S. introduced the Marshall Plan in 1945, stabilizing Western Europe and democratizing countries such as Italy, West Germany, Portugal, and Spain (Llewellyn, Southey, & Thompson, 2017). A key driving factor behind the willingness of the U.S. to provide assistance was the dependence of a notable portion of the U.S. economy on the existence of open trade relationships with a financially stable Western Europe (Llewellyn, Southey, & Thompson, 2017). Subsequently, the U.S. economy received a substantial boost from the Marshall Plan, as the majority of the $13.3 billion investment was used to purchase American goods and services (Llewellyn, Southey, & Thompson, 2017). National Security
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Since 1964, scholars have argued that democracy promotion is a rational tool for protecting U.S. national security interests because democratically governed countries do not go to war with other democracies (Epstein, Serafino, & Miko, 2007). This rationale is known as the Democratic Peace Theory (DPT). Proponents of the DPT argue that several factors explain the increased likelihood that democratic governments will not fight with one another: democratic leaders are accountable to a constituency who can vote them out of office; policymakers who are publically accountable are more likely to create diplomatic institutions to resolve international crises; democracies tend to not view countries with similar policy and governing structures as being hostile; and democracies tend to be wealthier, making them less inclined to engage in war to preserve their infrastructure and resources (Epstein, Serafino, & Miko, 2007). Critics of the DPT argue that this phenomenon is actually explained by the geopolitics of the post-World War II order and shared interests amongst countries, more so than by the democratic status of those countries (Epstein, Serafino, & Miko, 2007). This argument should be considered; however, there is a significantly larger amount of scholarly evidence that supports the original arguments for the DPT. Additionally, it has been argued that U.S. democracy promotion abroad is an effective tool for combatting terrorism. In the 2006 National Strategy for Combating Terrorism, the Bush II Administration cited democracy promotion as a long-term solution for winning the War on Terror (Epstein, Serafino, & Miko, 2007). By supporting the transitions of emerging democracies around the world, the U.S. is combatting terrorism in the long run by ensuring the existence of human rights; freedoms of speech, religion, assembly, and press; and independent judicial systems in former authoritarian countries (Epstein, Serafino, & Miko, 2007). Moreover, research shows that all of the aforementioned factors contribute to decreasing internal conflict and instability, which are often catalysts for terrorism (Fahey, 2010).
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Arguments against U.S. Democracy Promotion Destabilization A key criticism of democracy promotion is that it can destabilize a country or region, leading to further violence, instability, and repression by the recipient government (Epstein, Serafino, & Miko, 2007). This evidence is noteworthy because it suggests that, in certain cases, U.S. democracy promotion efforts can lead to an increase in repression and human rights violations abroad. Subsequently, this could potentially put the U.S. and its allies at greater risk of a national security threat. However, this destabilization effect is most often associated with democracy promotion through military intervention. Cost Effectiveness Other critics argue that U.S. democracy promotion is very expensive and provides little assurance or guarantee that long-term democratic governance will be attained (Epstein, Serafino, & Miko, 2007). Both Democratic and Republican members of Congress express concern that the U.S. is spending billions of dollars abroad on programs and initiatives that are failing to meet their expectations, while millions of Americans are suffering within their own country (Epstein, Serafino, & Miko, 2007). This critique demonstrates that U.S. democracy promotion is unlikely to garner significant support from American citizens and Congressional representatives unless the U.S. strategy is reformed to be more effective. Sovereignty The final criticism is that democracy promotion efforts infringe upon the national sovereignty of other states (Epstein, Serafino, & Miko, 2007). In international law, sovereignty means that the
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recognized government “possesses full control over the affairs within a territorial or geographic area” (Araujo, 2000). The principle of sovereignty is one of the most respected values of liberal democracies, and U.S. democracy promotion can be viewed as meddling in the domestic affairs of foreign nations, thereby violating said principle. However, in certain cases, the U.S. and other foreign nations can invoke the 2006 United Nations global commitment, Responsibility to Protect (R2P), to prevent and stop genocides, war crimes, ethnic cleansing, and crimes against humanity (Global Centre for the Responsibility to Protect, 2017). Sovereign nations committing such atrocities lose their right to govern, thereby allowing foreign nations, such as the U.S., to intervene in the domestic affairs of a sovereign nation in order to protect and save human lives.
U.S. Government Tools for Democracy Promotion Democracy-based Foreign Assistance One of the main tools used by the U.S. Government to promote democracy has been democracy-based foreign assistance, which is aid given by the U.S. to other countries to “support global peace, security, development efforts, and to provide humanitarian relief during times of crisis” (ForeignAssistance.Gov, 2017). In 1977, the U.S. Department of State established the Bureau of Democracy, Human Rights, and Labor to encourage democracy as a means to achieve global security, stability, and prosperity. The Bureau’s mission is to assist newly formed democracies in establishing robust democratic societies within their own countries (U.S. Department of State, 2017). In addition, the Bureau oversees the Human Rights and Democracy Fund (HRDF), which was established in 1998 to finance human rights and democratization activities such as election monitoring (U.S. Department of State, 2009).
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In 1983, President Ronald Reagan created the National Endowment for Democracy (NED), a U.S. nonprofit that strengthens democratic institutions across the globe by nurturing cross sector partnerships between private corporations and NGOs (Phillips & Holmes, 1996). NED provides assistance to “enhance the credibility and efficiency of democratic governance, to strengthen the private sector institutional and cultural framework, to broaden confidence in the democratic process, and to reinforce groups committed to democracy” (National Endowment for Democracy, 2017). In 2004, Congress authorized a new foreign assistance program called The Millennium Challenge Corporation (MCC) to improve aid by supporting the development of democratically governed recipients. Countries are required to “demonstrate their commitment to governing justly, investing in people, and promoting economic freedom by scoring relatively well on sixteen quantified indicators before gaining eligibility for assistance” (Recognizing U.S. Government Democracy Promotion Efforts, 2008). The MCC’s foreign aid account, titled the Millennium Challenge Account (MCA), currently operates on a $1.1 billion annual budget that serves over 46 foreign countries and territories (Tarnoff, 2017). Two key actors of democracy promotion in the U.S. Government are the Office of U.S. Foreign Assistance (OFA) and the U.S. Senate Subcommittee on State, Foreign Operations, and Related Programs. OFA is responsible for coordinating foreign assistance assets for the U.S. State Department and USAID. The U.S. Subcommittee on State, Foreign Operations, and Related Programs, along with the U.S. Senate Committee on Appropriations, has control over the budget for the U.S State Department and other foreign operations.
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Virginia Policy Review Military Intervention
One of the most controversial tools used by the U.S. Government to promote democracy is military intervention. Military intervention is defined as “the deliberate act of a nation or a group of nations to introduce its military forces into the course of an existing controversy abroad” (Dictionary of Military and Associated Terms, 2005). In recent scholarly debates surrounding the effectiveness of military interventions in promoting democracy, Peceny (1999) argues that U.S. military interventions have substantially improved the democratic progress made by countries who received the intervention. In addition, the author suggests that U.S. military intervention, on average, improves the likelihood that a country will experience long-term democratization when the intervention’s objective is framed as promoting free and fair elections (Peceny, 1999). There are other scholars who argue that Peceny’s (1999) findings on the effectiveness of military intervention are fundamentally flawed. Pearson, Walker, and Stern (2006) identified two major problems with Peceny’s analyses: his empirical findings regarding the effectiveness of imposed democratization rests on questionable empirical evidence and that "forcing [the nondemocratic nations] to be free” appears to be the least successful strategy for democratization (p. 65).
Technical Assistance Programs The U.S. also funds technical assistance programs to promote democracy in foreign nations. Technical assistance is a form of aid that provides the expert consultants, training, and research needed to promote development in a given country (Encyclopedia Britannica, 1998). It is one of the most heavily criticized forms of aid because there has been little evidence of its effectiveness; higher levels of technical assistance have shown no positive impact on a
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recipient nation’s economic growth (Greenhill, 2006). The underlying cause of technical assistance’s failure is that projects are often donor-driven and lack recipient country ownership and involvement (Greenhill, 2006). This leads to the implementation of programs and initiatives that are not culturally appropriate and fail to meet the specific needs of the recipient country. Thus, technical assistance has become a large expenditure by the U.S. Government that does not improve the situation or governance structure of the recipient country. However, it has been argued that technical assistance programs and trainings can be revised to more effectively promote democracy in foreign nations. This will require recipient countries taking more control over capacity building, a shift from one-sided conditionality to mutual commitments from donors and recipient governments, countries being free to determine their own paths to development, and recognition that development is a locally-driven process (Greenhill, 2006).
U.S. Democracy Promotion in Egypt under the Trump Administration President Trump has emphasized his intention to take a purely transactional approach in interactions with foreign nations (Hader, 2017). This suggests that U.S. democracy and human rights promotion in other countries will be put aside to pursue an “America first” foreign policy agenda. However, scholars have argued that this viewpoint is shortsighted because the objectives of incoming U.S. presidents with respect to democracy promotion tend to change once leaders transition from campaigning to governing (Carothers, 2007). New administrations often realize that democracy and its promotion abroad can be a useful tool for responding to unexpected international events (Carothers, 2007). An example of this is when the Bush II administration decided to invade Iraq in 2003. Leading up to the 2000 U.S. Presidential Election, George W. Bush campaigned on an isolationist platform
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that opposed U.S. intervention in the Middle East; however, once elected, the events of September 11, 2001 caused him to retract his policy, and the U.S. invaded Iraq. This decision cost U.S. taxpayers billions of dollars to install a democratic government in Iraq under the assumption that this action would protect U.S. national security interests. President Trump is likely to face a serious foreign policy decision regarding Egypt, in which democracy promotion can help aid the protection of U.S. economic and national security interests in the Middle East.
Policy Options This section will serve as an analysis of U.S. democracy promotion opportunities in Egypt under the Trump administration. It will begin by outlining several policy options that the U.S. Government can implement to promote democracy in Egypt. The options will be evaluated on their effectiveness and political feasibility. Finally, there will be a policy recommendation based on the results of the evaluations, and I will present an advocacy strategy for how to successfully gain support from key stakeholders. Option 1: Threaten to suspend existing U.S. foreign military aid to Egypt. In this option, the U.S. Government will send a formal correspondence to the appropriate personnel in the Egyptian government, informing them that the U.S. will suspend its $1.3 billion foreign military assistance package if the country does not meet certain benchmarks for democratic progress (Podrasky, 2015). Effectiveness: This option is likely be moderately effective in altering the behavior of President Sisi and the Egyptian government. Currently, the Middle East is plagued with crises, civil wars, and terrorism that have exacerbated the volatile and unstable nature of the region. The Egyptian government depends heavily on
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U.S. foreign military assistance to secure and protect its borders from outside threats (Kucera, 2016). Suspending U.S. foreign military aid will not only harm the Egyptian economy but will also reduce the militaristic capabilities of the Egyptian army to defend its country. Threatening to suspend U.S. foreign military aid will (potentially) increase President Sisi’s willingness to make democratic-oriented changes to his regime in order to maintain his country’s current level of U.S. assistance. Political Feasibility: Threatening to suspend U.S. foreign military assistance to Egypt is likely to have low political feasibility. The U.S. Congress and the Trump administration are unlikely to support this policy option because it could undermine U.S. national security interests by damaging the relationship between the U.S. and a strategic ally in the Middle East. President Obama was only able to suspend U.S. foreign military assistance to Egypt in 2013 because there was strong political support from the Democraticallycontrolled Senate to punish the Egyptian government, which was controlled by the military at the time, for its repressive crackdown on the Muslim Brotherhood (Labott, 2013). President Trump has been a vocal supporter of President Sisi and the Egyptian government; he reaffirmed the U.S.’ commitment to coordinating with Egypt to combat terrorism in the Middle East during President Sisi’s first visit to the White House on April 3, 2017 (Michaelson, 2017). Furthermore, the Republican-controlled Congress is likely to argue that Egypt is one of the U.S.’ strongest allies in the Middle East and that suspending U.S. foreign military assistance will damage the U.S.’ relationship with a strategic ally and weaken the country’s efforts to combat global terrorism. Option 2: Partner with European Allies to offer Egypt an economic package contingent upon democratic reforms. The U.S. has too often taken a soft stance on Egypt’s authoritarian government because it is one of the few countries in the Middle
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East that support U.S. national interests. To address this criticism, the U.S., in cooperation with European allies, should develop an appealing economic package that is contingent upon the Egyptian government taking noteworthy steps towards becoming a stable, democratic society (Hawthorne, 2014). Effectiveness: Creating a multilateral aid package with the U.S.’ European allies (Germany, the United Kingdom, France, and Italy) will build a coalition of influential nations that can assist the U.S. in its efforts to push for the democratization of Egypt. Gaining support from European allies will not only increase the size of the economic package used to incentivize Egypt, but it will also increase the amount of pressure directed at Egypt to move towards establishing a more democratic society, as countries in the European Union (EU) are Egypt’s largest and most significant trading partners (Mounir, 2015). Also, the Egyptian government will be given full autonomy over how it utilizes the economic aid package. This policy option will be highly effective in changing the behavior of the Egyptian government, as financial incentives can and have been used to successfully influence foreign leaders. One example comes from 1951, when the U.S. Congress provided economic and military assistance to the communist nation of Yugoslavia to encourage the country to remain independent from the influences of the Soviet Union. The approach was successful in influencing the behavior of Josip Broz Tito, President of Yugoslavia, who opposed the Soviet Union’s intervention in Czechoslovakia in 1968 (History Channel, 2017). Political Feasibility: For this policy option to work, the U.S. Congress and foreign allies will need to be convinced that this is a worthwhile strategy to protect their economic and national security interests. First, the U.S. Congress will need to be persuaded to spend more money on economic assistance to Egypt, which is already the second largest recipient of U.S. foreign aid. It can be argued that the Egyptian government is one of our strongest allies in a strategically important location and that the U.S. currently
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allocates 87 percent of its foreign aid to Egypt in the form of military assistance, so there is room to increase the amount of economic aid provided. Since the Trump administration has proposed cuts to the U.S. foreign aid package to Egypt, the money that was going to be cut should be put towards the multilateral economic aid package. Once Congress is onboard, the U.S. Government should reach out to European allies such as Germany, the United Kingdom, France, and Italy for contributions, because supporting a democratic Egypt is beneficial to the national economic and security interests of these nations. This option is rated as moderate-high on the scale of political feasibility. Option 3: Reallocate U.S. military aid to improve education programs in Egypt. A third option for expanding democracy promotion in Egypt is to focus on expanding U.S. investments in Egyptian education programs. This option intends to encourage Egyptian citizens to support democratic ideals, values, and institutions in their own country (Snider & Faris, 2011). More specifically, these programs would work on improving access to education for Egyptians, supporting school expansions, and further developing high school exchange programs between American and Egyptian students (Snider & Faris, 2011). This education development aid can be taken from a portion of the existing annual $1.3 billion foreign military aid budget that Egypt receives. Effectiveness: Education is one of the primary driving factors for developing stable and democratic nations (Glaeser, Ponzetto, & Shleifer, 2006). Investing in Egyptian education programs can help create a society that is more tolerant, open, and willing to accept democracy as a form of government. In addition, the U.S. should encourage the expansion of high school exchange programs
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between the U.S. and Egypt to strengthen the relationship between the two countries and expose Egyptian students to the benefits of a democratic society. The hope is that this exposure will encourage Egyptians to demand that their country is governed democratically. In terms of revitalizing the push for democratic change in Egypt, this option is likely to be ineffective. Political Feasibility: The U.S. Congress and the Trump administration are unlikely to take away money from the U.S. foreign military assistance package to invest in education initiatives because there is no guarantee that an educated Egyptian society will lead to a more democratic society and/or government. Currently, U.S. foreign military assistance to Egypt has a clear link to U.S. national security interests because it helps boost the militaristic capabilities of an ally who is aiding the U.S. in combatting ISIS and in the larger War on Terror; however, education cannot be directly linked to U.S. national interests and the effects, if any, will not be observed any time soon. Therefore, this option is likely to have low political feasibility. Option 4: Engage in public diplomacy to denounce the Egyptian government’s human rights violations. Another method for promoting democracy abroad is through public diplomacy. This includes public speeches, U.S. Government official overseas visits, and the implicit and/or explicit support for foreign democratic movements, such as protests. Effectiveness: Over the past couple decades, public speeches made by high-level U.S. Government officials have been used to demonstrate the U.S. commitment to democracy and its promotion around the world. In President George W. Bush’s second inaugural address, he declared that "it is the policy of the United States to seek and support the growth of democratic movements and institutions in every nation and culture, with the ultimate goal of ending tyranny in our world� (Dobriansky, 2005). However, it is
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extremely difficult to determine if these speeches have had an effect on the behavior of non-democratic regimes. In addition, the U.S. Government’s public denouncement of the Egyptian government’s crackdown on the Muslim Brotherhood in 2013 did little to change the military’s repressive actions against Egyptian citizens (Malsin, 2013). Therefore, public diplomacy would be largely ineffective. Political Feasibility: The Trump administration and Congress are likely to oppose the use of public diplomacy to denounce the authoritarian Egyptian government because Egypt is one of America’s strongest strategic allies in the Middle East. The U.S. Government has repeatedly displayed its willingness to ignore the human rights violations occurring in Egypt to protect its relationship with a key partner in the fight against ISIS and other adversaries in the Middle East. For that reason, Option 4 has low political feasibility. Option 5: Unilateral military intervention to install a democratic government in Egypt. The most controversial tool used by the U.S. Government to promote democracy is military intervention. Effectiveness: A military intervention to install a democratic government in place of the Sisi regime could work as a short-term solution; however, the U.S. military would have to effectively destroy the capacity of the Egyptian military to prevent a possible repeat of the 2013 Egyptian military coup that ousted former President Morsi. More importantly, even if the military intervention succeeded, this would require the U.S. to manage the Egyptian nation-building process, which is not something that any member of Congress, government agency, or U.S. citizen wants to be involved in. This demonstrates that military intervention in Egypt would be largely ineffective.
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Political Feasibility: Unilateral military intervention in Egypt to install a democratic government has zero to extremely low political feasibility. The Trump administration and the U.S. Congress will not authorize a unilateral military strike against Egypt, one of our largest allies, based on the human rights violations committed by the Egyptian government. Equally as important, military intervention as a tool for U.S. democracy promotion abroad is not supported by the American public. In February 2007, a poll conducted by Third Way found that 83 percent of Americans agreed that the U.S. cannot impose democracy by force on another country (World Public Opinion, 2017). These findings are significant because the U.S. Government has learned from historical precedence, such as the Vietnam War, that getting involved in military conflicts that the American public opposes will limit the tools that can be used in future U.S. foreign policy operations.
Recommendation I recommend Option 2: Partner with European Allies to offer Egypt an economic package contingent upon democratic reforms. A multilateral economic aid package is the most effective and politically feasible policy option to incentivize the Egyptian government to alter its repressive behavior without harming the U.S.’ relationship with a key strategic ally that supports U.S. national security interests in the Middle East and in the War on Terror.
Advocacy Strategy Lobby Relevant Members of the U.S. Congress The first segment of the advocacy strategy is to secure support for the multilateral economic aid package to Egypt by lobbying relevant members of the U.S. Congress. This will include scheduling meetings with the Republican and Democratic Party
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leaders and the House and Senate committee chairpersons involved in the decision-making process on U.S. foreign aid and appropriations. However, it is important to realize that Congress and the Executive Office, which are responsible for setting the U.S. Government’s agenda in terms of foreign policy objectives, are controlled by the Republican Party. When speaking with Republican leaders such as Speaker Paul Ryan (R-WI) and Senate Majority Leader Mitch McConnell (R-KY), it is important to frame the necessity of the economic package as a defensive strategy to protect U.S. national security interests in the Middle East. Egypt is one of our strongest allies in the region. Ensuring that the country will remain a stable and reliable partner, as a democratic nation, will aid the U.S. in the War on Terror. Alternatively, when speaking with Democratic leaders such as House Minority Leader Nancy Pelosi (D-CA) and Senate Minority Chuck Schumer (D-NY), one should frame the economic package as an instrument to encourage the Egyptian government to take concrete steps toward becoming a democracy in order to receive the multilateral economic assistance package. In this case, democracy promotion is framed as tool for protecting the human rights of the Egyptian citizens. It is important to reach out to Bob Corker (R-TN), Chairman of the Senate Foreign Relations Committee; Ed Royce (R-CA), Chairman of the House Committee on Foreign Affairs; and Hal Rogers (RKY), Chairman of the Senate Subcommittee on State, Foreign Operations, and Related Programs, to secure their support for the aid package. These individuals have the authority to present legislation to their respective committees, push these bills to a vote on the floor, and ensure that the money needed to implement the economic aid package is properly appropriated.
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To create a multilateral economic aid package for Egypt, contingent upon democratic reform, the U.S. Government will need to secure political and financial support from its European allies. The U.S. should use corporate lobbyists to pressure countries such as Germany, the United Kingdom, France, and Italy to sign on and commit to the multilateral economic package. However, this should not be difficult to accomplish because these countries already have strong economic ties and trade relations with the Egyptian government. The EU is Egypt’s biggest trading partner, accounting for 42 percent of Egyptian exports and 37 percent of imports, with the balance of trade in the EU's favor (European Commission, 2017). In 2017, German Chancellor Angela Merkel promised half a billion dollars to support Egypt’s economy. UK Foreign Secretary Boris Johnson visited Cairo on Feb. 25, 2017 to announce a $150 million financial package to support the country (Abdullah, 2017). Europeans not only have an economic incentive to contribute to the multilateral aid package, but they are also interested in convincing the Egyptian government to stop violating the rights of Egyptian citizens. Furthermore, with the increase of terrorism in Europe, it is in these countries’ national security interests to strengthen the stability, reliability, and democratization of a strategic ally in the fight against ISIS and in the War on Terror.
Partner with U.S. and European NGOs Lastly, it is crucial to gain the support of prominent U.S. and European NGOs that can lobby Congress on behalf of the Egyptian people. These organizations have a strong reputation for being able to influence the policy and budgetary decisions of the U.S. Government and should be used to advocate for a multilateral economic aid package that will serve as a major incentive for the Egyptian government to meet certain democratic benchmarks. These NGOs can mobilize their members, many of whom are
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voters; create social media marketing campaigns to gain support for the aid package; publish op-eds in national and regional news outlets; and organize peaceful protests in front of the U.S. Capitol to urge members of Congress to support this democracy-promoting initiative.
Conclusion The U.S. has developed a reputation for ‘ignoring’ human and civil rights violations committed by foreign governments–such as the Republic of China, Turkey, and South Sudan—to preserve strategic relationships that support U.S. economic and national security interests. The Trump administration is likely to continue this strategy in Egypt. However, this paper has demonstrated that there are policy options that can encourage the Egyptian government to transition toward a democracy without damaging U.S. relations with a strategic ally. Option 2: Partner with European Allies to offer Egypt an economic package contingent upon democratic reforms is the most effective and politically feasible policy option to incentivize the Egyptian government to alter its repressive behavior without harming the U.S.-Egyptian relationship, which supports U.S. national security interests in the Middle East and in the War on Terror. Phillip is a second year postgraduate MPP student at the Frank Batten School of Leadership and Public Policy from Plainsboro, New Jersey. He received his B.A. in Political Science from the University of Connecticut in May 2015. His main areas of interest include economic inequality, global migration, and humanitarian assistance. In 2017, he interned at the U.S. Department of State, working on refugee and migration issues in West Africa. Outside of VPR, he’s a member of the Batten Graduate Council, the Batten Admissions Ambassador program, and serves as the Diversity Liaison for employer relations at the UVA Career Center.
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History Channel. (2017). United States gives military and economic aid to communist Yugoslavia. Retrieved from http://www.history.com/this-day-in-history/united-statesgives-military-and-economic-aid-to-communist-yugoslavia Kucera, J. (2016, March 10). Georgia, Tajikistan, among countries most dependent on U.S. military aid. Eurasianet. Retrieved from http://www.eurasianet.org/node/77751 Labott, E. (2013, October 9). U.S. suspends significant military aid to Egypt. CNN. Retrieved from http://www.cnn.com/2013/10/09/world/meast/us-egypt-aid Llewellyn, J., Southey, J., & Thompson, S. (2017). The Marshall Plan. Alpha History. Retrieved from http://alphahistory.com/coldwar/marshall-plan Mahmood, F. T. (2015, November 9). Democracy prevention: The politics of the US-Egyptian alliance [Review]. Retrieved from http://jmepp.hkspublications.org/2015/11/09/democracyprevention-brownlee-review/ Malsin, J. (2013, August 27). Egyptian military crackdown leads to arrest of American citizen. Time. Retrieved from http://world.time.com/2013/08/27/egyptian-militarycrackdown-leads-to-arrest-of-american-citizen/ Michaelson, R. (2017, April 2). Warm welcome awaits Sisi as Trump rolls out red carpet for Egypt strongman. The Guardian. Retrieved from
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http://www.theguardian.com/world/2017/apr/02/abdel-fatahal-sisi-donald-trump-egypt Mounir, H. (2015, September 29). Egypt’s largest trading partners are European, Arab countries: CBE. Daily News Egypt. Retrieved from http://www.dailynewsegypt.com/2015/09/29/egypts-largesttrading-partners-are-european-arab-countries-cbe National Endowment for Democracy. (2017). Statements of principles and objectives. Retrieved from http://www.ned.org/about/statement-of-principles-andobjectives/ Pearson, F. S., Walker, S., & Stern, S. (2006). Military intervention and prospects for democratization. International Journal of Peace Studies, 11(2), 63-86. Peceny, M. (1999). Forcing them to be free. Political Research Quarterly, 52(3), 549-582. Phillips, J., & Holmes, K. (1996, September 13). The National Endowment for Democracy: A prudent investment in the future. The Heritage Foundation. Retrieved from http://www.heritage.org/trade/report/the-nationalendowment-democracy-prudent-investment-thefuture Podrasky, J. (2015, January 24). Can the US still promote democracy in Egypt? Muftah. Retrieved from https://muftah.org/can-us-still-promote-democracy-egypt/ Recognizing U.S. Government Democracy Promotion Efforts. (2008, May 8). Retrieved from http://cddrl.fsi.stanford.edu/sites/default/files/res/Reorganizi ng.pdf
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Snider, E. A, & Faris, D. M. (2011, September 15). The Arab Spring: U.S. democracy promotion in Egypt. Middle East Policy, 18(3), 49-62. Stewart, F. (2002, February 9). Root causes of violent conflict in developing countries. British Medical Journal, 342(7333), 342-345. Sukhorolska, I. (2016, January 3). Public diplomacy of western world countries as a tool of democracy promotion. Journal of Liberty and International Affairs, 1(3). Tarnoff, C. (2017, January 11). Millennium challenge corporation. Congressional Research Service. Retrieved from https://fas.org/sgp/crs/row/RL32427.pdf Technical assistance. (2013). In The Encyclopedia Britannica. EncyclopĂŚdia Britannica, Inc. Retrieved from http://www.britannica.com/topic/technical-assistance U.S. Department of State. (2017). Bureau of democracy, human rights, and labor. Retrieved from http://www.state.gov/j/drl U.S. Department of State. (2009). DRL programs, including human rights democracy fund (HRDF). Retrieved from https://2001-2009.state.gov/g/drl/p/ Weinbaum, M. G. (1986, May). Dependent development and U.S. economic aid to Egypt. International Journal of Middle East Studies, 18(2), 119-134. World Public Opinion. (2017). Promoting democracy and human rights. Retrieved from http://www.americansworld.org/digest/overview/us_role/democracy.cfm
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Does Socioeconomic Inequality Undermine Local Government Credibility in China? Evidence from China Family Panel Studies (CFPS) By Jingyuan Qian
Abstract In this study, I argue that Chinese citizens’ feelings of socioeconomic inequality will affect their approval of government performance at the local level. Using data from China Family Panel Studies’ (CFPS) 2014 results, I present evidence that individuals who believe that China has a greater inequality problem are more likely to view local authorities less favorably. My study provides a theoretical framework to explain the link between perceptions of inequality and government approval and ends with a brief discussion of how this finding will improve the current understanding of political trust in authoritarian states like China.
I. Introduction Despite the global surge of democratization in the early 21st century, the authoritarian rule of the Chinese Communist Party (CCP) has not faced significant opposition or popular resistance in nearly three decades. Contrary to most one-party regimes, the Chinese Government consistently enjoys a high degree of public approval among its citizens. Many theories have been proposed to explain the popularity of the Chinese regime. One theory argues that the CCP’s public support comes from China’s stellar economic growth since the 1980s. According to this theory, the legitimacy of the Chinese regime depends on its sustained ability to fulfill China’s economic development goals. An alternative theory views
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the Chinese regime’s popularity from an institutional perspective, arguing that Chinese citizens’ favorable views of the regime are constructed through strict media censorship, propaganda in education, and invocation of nationalist loyalism. A third theory attempts to explain the CCP’s high approval ratings as a result of the regime’s flexibility and adaptability. According to the theory, by interacting with citizens and gathering their feedback and opinions through multiple non-electoral channels, the regime is always available to make policy adjustments in response to the citizens’ grievances and thus reduce public discontent. In this paper, I wish to further develop the first theory that Chinese authorities achieve their legitimacy through sustained economic development. Instead of focusing on the overall economic growth under CCP rule, I hope to understand how economic inequality— the uneven distribution of wealth accrued from China’s rapid economic growth—affects citizens’ views of the government. As previous studies have revealed, the wealth gap among social classes has been steadily increasing in China, which has led to a severe lack of upward mobility and created a large disadvantaged population deprived of socioeconomic opportunities. The economic disparity in China is partially caused by the unbalanced development strategy of the Chinese Government, which places the economic goal of maintaining GDP growth above the social needs for redistributive justice and social equality. How does socioeconomic inequality affect the popular sentiment toward the Chinese authorities? In this paper, I argue that citizens’ feelings of economic inequality will undermine their approval of Chinese government performance. In Chinese political traditions, shaped by both long-term Confucian philosophy and modern Communist ideology, maintaining social fairness is considered an essential function of the state. Additionally, China’s leadership has made repeated promises to promote social equality and has claimed that the reduction of the wealth gap is a key policy priority for the government. Consequently, when citizens observe the increasing
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socioeconomic inequality, they tend to interpret it as a signal of the governments’ failure to accomplish a key policy goal, rather than a result of individual differences. Specifically, I argue that Chinese citizens tend to place more blame on local authorities than on the central government for the failure to ensure economic equality. There are two reasons for this difference in the amount of blame the public assigns to the different levels of government. First, since local officials are responsible for implementing specific policies, they have more direct interactions with the constituency and are under closer scrutiny from citizens. This closer engagement with citizens makes local officials more likely to receive criticism for alleged policy failures. Second, under China’s censorship rules, the media are required to portray the central government in a positive and laudatory manner, but they are given some freedom to criticize local authorities and expose their corruption and misdeeds. As a result, local governments are more likely to be held accountable for their perceived failure to address inequality in their jurisdictions. Data from the China Family Panel Survey (CFPS) results in 2014 show some evidence in favor of my hypothesis in this study. An ordered probit model is used to evaluate the association between citizens’ perception of socioeconomic inequality in China and their evaluation of local governance. When controlling for respondents’ demographic factors, socioeconomic conditions, and pre-existing political leanings, respondents’ assessments of socioeconomic inequality are strongly correlated with their evaluations of local government performance. In particular, a citizen with a stronger perception of inequality is more likely to give a negative assessment of local government performance. This result provides evidence that citizens who have stronger feelings on China’s inequality problem tend to view local government performance more unfavorably. This study provides
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new insights into the notion of “performance legitimacy,” that is, the popular support of the Chinese regime not only depends on its ability to sustain economic growth, but also on how the benefits of economic growth are distributed among different groups of citizens.
II. Literature Review: Understanding the Legitimacy of the Chinese Regime Numerous studies attempt to explain the apparent longevity and stability of CCP’s rule. A prevalent theoretical approach to understanding CCP’s enduring rule, often called “performance legitimacy,” is that the Chinese Government’s public support depends on its sustained ability to accomplish a series of concrete policy goals (Goldman & MacFarquhar, 1999; Zheng & Wang, 2000; Tsai 2007; Laliberte & Lanteigne, 2008; Zhu, 2011; Yang & Zhao, 2014). These policy goals include maintaining strong economic performance (White, 1986; Dittmer & Liu, 2006; Holbig & Gilley, 2010), promoting good governance and stability (Tang, 2005; Shue, 2010), and strengthening China’s status as an emerging global power (Zhao, 2005; Darr, 2011; Weiss, 2013; Johnson et al., 2014). The Chinese regime justifies its authority by arguing that these performance goals cannot be achieved without CCP’s effective leadership. On the other hand, Chinese citizens’ acceptance of CCP’s legitimacy is conditioned upon its ability to deliver certain policy outcomes and generate economic benefits. This model perceives the public support for the Chinese Government as the result of a pragmatic bargain in which Chinese citizens willingly trade political loyalty in exchange for fulfillment of practical economic interests. One criticism of this economic-rationalist approach is that it fails to consider the Chinese regime’s ability to proactively shape citizens’ political views. Many scholars argue that citizens’ attitudes toward the Chinese Government are not formed spontaneously by themselves but instead are constructed by the government through a
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complex mechanism of social control and persuasion (Zeng, 2014; Brady, 2008; Brady, 2009). Political scientists extensively studied the effects of social control measures—such as the censorship of media and Internet forums (MacKinnon, 2008; King et al., 2013; Huang, 2015; King et al., 2013), mass propaganda campaigns in the public sphere (Lynch, 1999; Holbig, 2006; Qian, 2014; Zhao, 2016), and the systematic silencing of collective opposition through force and coercion (Thornton, 2002; Gries & Rosen, 2004; MacKinnon, 2011; Wang, 2014)—in shaping CCP’s public image (Edney, 2015). Their studies show that the Chinese Government can effectively shape its citizens’ political views by manipulating the channels of public information and civic participation. The theory that views CCP’s popular support as a result of state propaganda and manipulation is not without flaws. Many recent scholars point out that although it is true that the Chinese Government makes strong efforts to shape public opinion in its favor, it also actively responds to public sentiment by showing strong flexibility and adaptability in its governance (Oi, 2003; Nathan, 2003; Brodsgaard & Zheng, 2006; Shambaugh, 2008; Dickson, 2016; Shen & Tsai, 2016; Li, 2017). Instead of suppressing all voices of opposition that question its governance, the regime selectively responds to citizens’ criticisms and grievances by making practical adjustments to its policy based on popular feedback (King et al., 2013). The regime relies on a variety of non-electoral channels—such as opinion polling, tracking of Internet posts, and analysis of citizen complaint letters—to understand citizens’ policy preferences (Brian & Li, 1995; Minzner, 2006; Dimitrov, 2014; Hartford, 2015; Distelhorst & Hou, 2017). The CCP’s adaptability to public opinion not only explains many of its major policy changes over time, but also contributes to its legitimacy by reducing popular discontent with its governance. This theory reveals that, in lieu of an electoral mechanism to justify its legitimacy, non-democratic regimes like China can rely on multiple
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non-electoral means to address popular will and strengthen their political stability. Many empirical studies have been designed to test these theories and measure the factors that influence CCP’s legitimacy. The “performance legitimacy” argument is well supported by empirical evidence. Various surveys show that economic opportunities and competent governance are citizens’ main reasons for supporting the Chinese government (Chen, 1997; Shi, 2001; Munro et al., 2013). Specifically, individuals who are better off economically show stronger trust in the government, which may suggest a patron-client relationship between the regime and its economic beneficiaries (Kennedy, 2009). Previous survey results also support the argument that media, education, and propaganda campaigns can increase Chinese citizens’ political loyalty (Bernstein & Lü, 2000; Chen & Shi, 2001; Li, 2004). Propaganda through education seems to have a mixed effect on political loyalty: although more educated citizens display higher levels of support for the government, citizens at the highest level of education are more resistant to political indoctrination (Kennedy, 2009). Finally, recent studies show that higher responsiveness to citizens by the government may improve the citizens’ political trust. In particular, high-quality constituency services and easier access to government officials are strongly associated with higher public approval of government agencies (Jiang & Xu, 2009; Saich, 2012; Distelhorst & Hou, 2017). Previous studies also highlight that central and local governments in China do not receive the same level of public trust from citizens (Li, 2004; Yang et al., 2014; Su et al., 2016; He & Su, 2017; Zheng, 2017). Empirical surveys unanimously show that citizens’ political trust in the central government is significantly higher than their trust in local authorities. Moreover, political trust in the central government seems to have less variation and be less affected by individual factors. In later parts, I will present a theory to explain the logic behind the “hierarchical” political trust of the Chinese Government.
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III. Socioeconomic Inequality and Political Trust in China: An Explanatory Framework Many previous studies have attempted to understand how socioeconomic inequality—defined as the unequal possession of social and economic resources among individuals—affects citizens’ attitudes toward government. Although empirical studies on China (Sun & Guo, 2013; Zheng, 2017) and Europe (Anderson & Singer, 2008; Steijn & Lancee, 2011) seem to suggest a negative correlation between inequality and political trust in government, these studies fail to present a coherent theory on how socioeconomic inequality affects citizens’ political views. In order to understand the underlying logic of inequality’s effect on political trust, I will present a theoretical framework and an empirical study to address three relevant questions. First, is it the inequality per se, or each individual’s subjective perception of inequality, that will impact citizens’ trust in government? Second, will inequality only affect the political views of disadvantaged citizens in the society, or will it undermine political trust throughout the entire population? Third, why are Chinese nationals more likely to blame the government for inequality than citizens in many other countries? This third question is more relevant to China’s specific condition. Previous surveys repeatedly show that a high percentage of Chinese citizens (43%, according to Pew Research) consider the government to be the major cause of inequality, compared to citizens in other countries (Graph 1) (“Emerging and Developing”, 2014).
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a. Path Dependency of Confucian and Communist Egalitarianism The concept of legitimacy in China is deeply influenced by its historical traditions and narratives (Zhao, 2009). The view of the government as a defender of equality has an enduring political and philosophical root in China. Confucianism, the official ideology of Imperial China, puts strong emphasis on social fairness and equal distribution of wealth in its teachings. Confucian doctrines like “what is under heaven is for all”1 and “scarcity is a lesser concern than inequality”2 had an overarching impact on governance patterns in Imperial China. In Chinese history, ensuring the equal allocation of farmland was a fundamental role of the Imperial Court, and concentration of land property into the hands of a few was a justified cause for peasant rebellion (Myers, 1982). Power contenders and new dynastic rulers frequently justified their legitimacy by promising to redistribute social wealth and establish an egalitarian society. In the early modern era, Confucianism’s egalitarian ideals have been inherited by political leaders such as Sun Yat-Sen and Mao Zedong to justify their revolution against the old regime (Wakeman, 1975). More recently, Maoist China (1949-1976), as a totalitarian communist economy, also had an enduring impact on the concept of economic justice among Chinese citizens, especially with regard to the government’s role in achieving equality. In the official ideology of Marxism-Leninism, establishing an egalitarian and classless society is the ultimate goal of communism and a political obligation of the state. The socialist policies of the Mao era—job security, generous employment benefits, and equalized income—contrast sharply with the rising unemployment, widening income gap, and social stratification following the Post-Mao reforms (Whyte, 2012). Tianxia wei gong (天下为公) – from Book of Rites, Chapter Nine. Buhuan gua er huan bujun (不患寡而患不均) – from Analect of Confucius. 1 2
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From the point of view of many elderly and middle-aged citizens in particular, inequality is a natural result of the government’s betrayal of an important political obligation. b. Inequality as both a Policy Failure and a Policy Outcome For many Chinese citizens, the contemporary policy structure affects inequality in both negative and positive ways. On one hand, the current policy agenda fails to address the existing inequality problem. All post-Mao political leaders (Presidents Deng Xiaoping, Jiang Zemin, Hu Jintao, and Xi Jinping) have made repeated promises to improve fairness and reduce social disparity, while in reality, the income gap and class stratification in society have been consistently growing (Dollar, 2007). Instead of making redistributive justice a policy priority, the Chinese Government is widely criticized for placing the need to achieve economic growth above everything else (Gao, 2012; Liang, 2015). In many provinces, the GDP record has become the most important criteria for local officials to get promoted (Cheng, 2012). To many citizens, this pragmatist approach to economic development fails to sufficiently address the inequality problem. On the other hand, socioeconomic inequality is also viewed as the direct outcome of government policies. Some citizens express the view that the authorities not only fail to solve the growing inequality problem, but also directly contribute to the problem through mean-spirited policies. It is a common belief that the “powerful” and the “rich” have formed an exclusive interest group to protect their private interests, while blatantly disregarding the needs of the vast majority of people. Many economic reform measures—from the privatization of state-owned factories to the confiscation of farmland for real estate development—are viewed by many as unfairly benefiting a small privileged class at the expense of the general public (Li, 2004; Wang, 2007) This mentality of being betrayed by a corrupt government has strengthened the link between inequality and trust in government.
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c. The Hierarchical Structure of Government Trust A remaining problem is how to explain Chinese citizens’ significantly higher support for the central government compared to local governments. Based on previous research, I propose two reasons to explain the hierarchy of political trust in China. The first reason is related to China’s political structure as a regionallydecentralized authoritarian system (Xu, 2011). Under this structure, the central government serves as a core decision-making and regulatory body, while local authorities are vested with significant discretionary power to interpret and implement central government guidelines. Local governments are entitled to vast power to implement laws and policies established by Beijing and are granted broad influence on the socioeconomic development of local constituencies. The decentralized governance structure leads to the widespread idea that corrupt local officials distort the well-intended policies made by Beijing’s leadership (Li, 2004). Additionally, since the citizens have more firsthand engagement with local authorities, they are more likely to intuitively attribute policy failures to local officials who directly carry out these policies. Another reason for the hierarchy of political trust is the differentiated enforcement of media censorship in China. Normally, the state propaganda machine makes stronger efforts to shape the positive image of the central government while allowing the criticism of local authorities to a limited degree (see Table 1). As a result of the differentiated media portrayal of the central government and local authorities, the Chinese citizens’ trust in the former is significantly higher than that in the latter. Consequently, when a policy failure occurs, citizens tend to attribute the blame to local authorities for their poor implementation of policies rather than to bad decisions made by the central government.
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Table 1: Construction of Public Attitudes toward Chinese Government Institutions Media Positivity High Low Law Enforcement High Agencies (police, Local Government Implementation military, etc.) Accountability State-owned Enterprises, Low Central Government Functional institutions This analytical framework is drawn roughly from Li (2002), Li (2008), and King et al. (2012) on Chinese political trust. It considers two factors that affect the citizens’ trust of Chinese political institutions: 1) whether an institution receives positive media coverage, and 2) whether the institution is held accountable for the consequences of policy implementation. Combinations of the two factors lead to differentiated levels of political trust.
IV. Empirical Data Strategy a. Source and Structure of Data I designed an empirical study to explore the relationship between Chinese citizens’ perceptions of socioeconomic inequality and their views of local government performance. The key dataset used in my analysis is the 2014 results of the Chinese Family Panel Survey (CFPS), conducted by Peking University. The intended goal of this cross-sectional survey is to track socioeconomic development in China and understand citizens’ views on a variety of issues. A random sample of over 10,000 families was invited to participate in the survey. A stratified sampling method was used to ensure balanced representation across geographical regions, settlement types (rural/urban), demographics, and socioeconomic status. Trained volunteers administered this survey through in-person interviews. Each interview included approximately 300 questions and lasted around 1.5 hours. The names and personal information of respondents are classified to ensure individual privacy, but each of the respondents is assigned a unique ID to allow follow-up interviews.
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b. Variables of Interest Key Dependent Variable. The dependent variable of this study is attitude towards local government performance, as assessed by a multiple-choice question. The question takes the following form: “What is your general attitude toward the performance of your county/city/district government in the current year?” Five ranked choices are provided for the respondent to choose: “significant achievement”; “some achievement”; “not much achievement”; “no achievement”; and “worse than before.” The respondents were assured that their answers would be kept strictly anonymous and would not lead to any consequences. Key Independent Variable. The key independent variable of interest is the assessment of the degree of inequality in China. The question is expressed as follows: “In your opinion, how serious is the inequality between the rich and the poor in today’s China?” The respondent’s answer is expressed as a ranked number between one and 10. The number one represents “least serious” and 10 represents “most serious.” For example, if a respondent were to answer, “China does not have a problem of inequality,” the number “zero” would be recorded. Controls. In order to exclude the impact of confounding factors, this study controls for three groups of variables that may correlate with the respondents’ political attitudes. Firstly, demographic factors such as gender, age, marital status, and geographical location are controlled for to exclude the impact of those individual characteristics. Secondly, an individual’s total income level is controlled for to isolate the effect of socioeconomic conditions on one’s perception of inequality. An interaction term is also included to examine the combined impact of economic status and feelings of inequality. Thirdly, indicators that show an individual’s pre-existing attitude toward the Chinese Government are controlled for in the analysis. These factors are Communist Party membership,
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affiliation with governmental or political institutions, and previous encounters with local officials’ misbehavior. A summary of variables is shown in Table 2. c. Statistical Method Based on the framework laid out above, I built an ordered probit model to capture the relationship between perceptions of inequality and trust in government. This method has been widely used in opinion survey research and has been credited as an effective method to analyze categorical outcome variables (Lu, 1999; Diener & Biswas-Diener, 2002; Boes & Winkelmann, 2006; Meng & Florkowski, 2014; Bagozzi et al., 2014; Yen & Zampelli, 2017). This model starts with a linear regression equation y* = βi xi + ε, where y* indicates the citizen’s underlying evaluation of local government performance, xi are independent variables used to predict the outcome y*, βi are regression coefficient vectors for independent variables, and ε is the error term. The model also assumes that the observed outcome y, provided by respondents as an ordered performance score from one (“significant achievement”) to five (“worse than before”), is derived from each y* according to the following algorithm: y = m, if αm-1 ≤ yi* ≤ αm (m = 1, 2, 3, 4, 5). In this equation, αm are “cut-off points” which convert the unobserved continuous variable y* into an observed categorical variable y. The values of αm can be estimated using the maximum likelihood estimation (MLE) method. Furthermore, we can estimate the probability of observing each response, given certain x values, using the following formula:
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Pr (y = m | xi) = Ό (ιm - βi xi) - Ό (ιm-1 - βi xi) (Ό is the CDF of normal distribution) Subsequently, we can calculate the marginal effect (MEF) of each independent variable xi to indicate how a unit change in xi will impact the probability of observing each government approval score: MEF =
đ?œ• Pr(đ?‘Œ=đ?‘š|đ?‘Ľ) đ?œ•đ?‘‹đ?‘–
= [Ό (ιm - βi xi) - Ό (ιm-1 - βi xi)] βi
Tables 3 to 5 report the outputs of the statistical analysis. Table 3 shows the summary statistics of all dependent and explanatory variables, Table 4 presents the results of the ordered probit regression using four different specifications, and Table 5 reports the marginal effects of each explanatory variable on the probability of obtaining each of the five government approval levels.
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V. Results The regression results provide support for the theory that Chinese citizens’ feelings of socioeconomic inequality will affect their approval of government performance at the local level. Table 4 shows that the citizens’ feelings of socioeconomic inequality are strongly correlated with their approval of local authorities’ performance. This effect remains significant even after controlling for an individual’s demographic, economic, and political indicators. Contrary to their subjective perception of inequality, the citizens’ actual income levels do not have a significant impact on their attitudes toward local government. The results also show that one’s pre-existing political views are strongly associated with their perception of government competency. Three indicators of political attitudes—experience of government misdeeds, employment with government, and being a CCP member—all show strong correlation with government approval, which means that an individual’s existing political stance will shape their perception of government performance. Generally, the results provide statistical evidence to support the relationship between socioeconomic disparity and local government approval. Table 5 evaluates the quantitative impact of independent variables on the probability of observing each level of approval of the government. The results show that respondents who have a stronger perception of socioeconomic inequality are less likely to evaluate government performance favorably. A one-point increase in the perceived inequality level reduces the probability of observing a score of 1 (“significant achievement”) by 0.4% and the probability of observing a score of 2 (“some achievement”) by 1.39%. Furthermore, respondents who perceive more socioeconomic inequality tend to give negative assessments of government work. A one-point increase in the inequality assessment score leads to a 0.62% increase in the odds of receiving a score of 3 (“not much
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achievement”), a 0.89% increase in the odds of receiving a score of 4 (“no achievement”), and a 0.29% increase in the odds of receiving a score of 5 (“worse than before”). All of the results mentioned above have strong statistical significance (p<0.001). These results provide evidence to support the theoretical framework in this paper: individuals who have a stronger feeling of inequality tend to view local government performance more negatively. Despite strong support from the data, this research struggles to overcome several limitations. The first challenge is the accuracy and reliability of survey responses. Since the survey asked respondents to represent their views on a simple numerical scale from one to 10, the respondents’ different criteria of measurement may lead to variation in results. Additionally, since the survey is conducted through in-person interviews, respondents may be reluctant to reveal their true opinion of Chinese government due to safety concerns. This problem would potentially lead to an upward bias in their evaluation of government performance. Finally, due to the scarcity of available data, my study only utilizes data in one single year (2014) to evaluate the relationship between inequality and government approval. Hopefully, when more data becomes available, a multi-year study can be conducted to understand whether a change in the perception of socioeconomic inequality will lead to a dramatic change in the citizens’ approval of local governments.
VI. Conclusion This study improves the long-standing theory that popular support for the Chinese Government depends on its ability to sustain economic performance. My analysis of survey results suggests that a majority of Chinese citizens consider socioeconomic inequality a problem, and that the increase in the socioeconomic gap does undermine citizens’ approval of government performance at the
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local level. Instead of overly focusing on overall economic growth, Chinese policymakers should take proper redistributive measures to reduce the social wealth gap in order to reduce popular discontent.
Jingyuan Qian, MPP (jingyuan.qian@duke.edu), is a Senior Research Assistant at Duke-Margolis Center for Health Policy, Fuqua School of Business at Duke University. Corresponding Address: Duke University in DC, 5th Floor, 1201 Pennsylvania Ave NW, Washington, DC 20004. The author would like to thank Professor George Akerlof (Georgetown University), Jing Qian (Princeton University), Kaishuo Chen (Boston College), Haimo Li (University of Houston), and Xiaomeng Hu (San Jose State University) for their helpful guidance and suggestions in the writing of this paper. All errors and inaccuracy found in this paper, of course, are my own.
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Gao, D. (2012, September 29). GDP zhìshàng zhèngjìguān shì zhìyuē zhuǎnbiàn jīngjìfāzhǎn fāng shì de píngjǐng. [The “GDP supremacy” mindset is the bottle neck in the reform of economic development approach.] Xiandai Shangye, 8. 82. Goldman, M., & Macfarquhar, R. (1999). The paradox of China's post-Mao reforms. Cambridge, MA: Harvard University Press. Hartford, K. (2005). Dear Mayor: Online communications with local governments in Hangzhou and Nanjing. China Information, 19(2), 217-260. Hays, G. P., & Rosen, S. (2004). State and society in 21st century China: Crisis, contention, and legitimation. London: Routledge. He, J., & Su, Z. (2017, January 16). Anti-system Contentions and Authoritarian Response in China: Evolution and Mechanisms. Journal of Asian and African Studies, 1–19. Holbig, H., & Gilley, B. (2010, June). Reclaiming legitimacy in China. Politics & Policy, 38(3), 395-422. Holbig, H. (2006, March). Ideological reform and political legitimacy in China: Challenges in the post-Jiang era (Working Paper No. 18). Hamburg: German Institute of Global and Area Studies. Jiang, M. & Xu, H. (2009, May). Exploring Online Structures on Chinese Government Portals: Citizen Political Participation and Government Legitimation. Social Science Computer Review, 27(2), 174-195. Johnson, C. K., Bower, E. Z., et al. (2014, June 11). Decoding China's emerging "great power" strategy in Asia: A report of the
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CSIS Freeman Chair in China Studies. Washington, DC: Center for Strategic and International Studies. Kennedy, J. J. (2009, October). Maintaining Popular Support for the Chinese Communist Party: The Influence of Education and the State-Controlled Media. Political Studies, 57(3), 517-536. King, G., Pan, J., & Roberts, M. E. (2013, May). How Censorship in China Allows Government Criticism but Silences Collective Expression. American Political Science Review, 107(2), 326-343. LaliberteĚ , A., & Lanteigne, M. (Eds). (2008). The Chinese partystate in the 21st century: Adaptation and the reinvention of legitimacy. London: Routledge. Li, L. (2004, April). Political Trust in Rural China. Modern China, 30(2), 228-258. Lynch, D. C. (1999). After the propaganda state: Media, politics, and "thought work" in reformed China. Stanford, CA: Stanford University Press. MacKinnon, R. (2011, April). China's "Networked Authoritarianism". Journal of Democracy, 22(2), 32-46. MacKinnon, R. (2008, January). Flatter world and thicker walls? Blogs, censorship and civic discourse in China. Public Choice, 134(1-2), 31-46. Minzner, C. F. (2006). Xinfang: An Alternative to Formal Chinese Legal Institutions. Stanford Journal of International Law, 42(1), 103-179. Munro, N., et al. (2013, August 31). Does China's Regime Enjoy 'Performance Legitimacy'? An Empirical Analysis Based on Three Surveys from the Past Decade. APSA 2013 Annual Meeting Paper.
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Myers, R. H. (1982). Customary law, markets, and resource transactions in late imperial China. In Ransom, R. L., Sutch, R., & Walton, G. M. (Eds.), Explorations in the new economic history: Essays in honor of Douglass C. North (273-298). New York, NY: Academic Press. Nathan, A. (2003). Authoritarian Resilience. Journal of Democracy, 14(1), 6-17. O'Brien, K. J., & Li, L. (1995). Politics of lodging complaints in rural China. China Quarterly, 143, 756-783. Oi, J. (2000, October). Bending without Breaking: The Adaptability of Chinese Political Institutions (Working Paper No. 61). Stanford, CA: Stanford Center for International Development. Qian, J. (2014). From performance to politics? Constructing public and counterpublic in the singing of red songs. European Journal of Cultural Studies, 17(5), 602-628. Saich, T. (2012, November). The quality of governance in China: The citizens' view (Working Paper). Cambridge, MA: Harvard Kennedy School. Shambaugh, D. (2008). China's Communist Party: Atrophy and adaptation. Washington, DC: Woodrow Wilson Center Press. Shen, X., & Tsai, K. S. (2016, November). Institutional Adaptability in China: Local Developmental Models Under Changing Economic Conditions. World Development, 87, 107-127. Shi, T. (2001, July). Cultural Values and Political Trust: A Comparison of the People's Republic of China and Taiwan. Comparative Politics New York, 33(4), 401-419.
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Shue, V. (2004). Legitimacy Crisis in China? In Gries, P.H., & Rosen, S. (Eds.), State and society in 21st century China: Crisis, contention, and legitimation (24-49). London: Routledge. Steijn, S., & Lancee, B. (2011, November). Does income inequality negatively affect general trust? Examining three potential problems with the inequality-trust hypothesis (GINI Discussion Paper No. 20). Amsterdam: Amsterdam Institute for Advanced Labour Studies. Su, Z., Ye, Y., He, J., & Huang, W. (2016, December). Constructed Hierarchical Government Trust in China: Formation Mechanism and Political Effects. Pacific Affairs, 89(4), 771-794. Sun, W., & Guo, Y. (Eds). (2015). Unequal China: The political economy and cultural politics of inequality. London: Routledge. Tang, W. (2005). Public opinion and political change in China. Stanford, CA: Stanford Press. Thornton, P. M. (2002, September). Framing Dissent in Contemporary China: Irony, Ambiguity and Metonymy. The China Quarterly, 171, 661-681. Tsai, K. (2007). Capitalism without democracy: The private sector in contemporary China. Ithaca, NY: Cornell University Press. Wakeman, F. (1975). The fall of imperial China. New York, NY: Free Press. Wang, F. (2007, October 16). Boundaries of inequality: Perceptions of distributive justice among urbanities, migrants and peasants (Working Paper). Irvine, CA: Center for the Study of Democracy. Wang, Y. (2014, March). Coercive capacity and the durability of the Chinese communist state. Communist and Post-Communist Studies, 47(1), 13-25.
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Zhao, S. (2016, November/December). The Ideological Campaign in Xiâ&#x20AC;&#x2122;s China: Rebuilding Regime Legitimacy. Asian Survey, 56(6), 1168-1193. Zheng, Y., & Wang G. (Eds.). (2000). Reform, Legitimacy, and Dilemmas: China's Politics and Society. Singapore: Singapore University Press. Zheng, Z. (2017, June). How Inequality Influences Political Trust? Investigating the Change of Political Trust in China from a Social Structure Approach. Hong Kong: ISA International Conference. Zhu, Y. (2011, June 1). "Performance Legitimacy" and China's Political Adaptation Strategy. Journal of Chinese Political Science, 16(2), 123-140.
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The Community Reinvestment Act at 40: A Careful Review of the Reviews By Josh Silver This article originally appeared in Shelterforce. Every so often, an effort is made to collect articles by leading practitioners, community organizations, and academics about the effectiveness of the Community Reinvestment Act (CRA). The last was in 2009, when the San Francisco and Boston Federal Reserve Banks published a volume about perspectives on the future of the Community Reinvestment Act (Essene et al., 2009). Cityscape, a research and policy publication of the Department of Housing and Urban Development (HUD), published an issue devoted to CRA and its upcoming 40th anniversary this past October. With a new administration planning changes to banking policy, including a review of CRA, this publication is timely. I aimed for a careful read of the articles in the HUD volume because they cover a range of critical issues for CRA, such as whether its current implementation is effective in increasing access to credit and capital for traditionally underserved communities, whatâ&#x20AC;&#x2122;s working well and what could be improved, and how should CRA evolve as the banking world changes. No one volume can answer all of these critical questions definitely, but this volume is a good start and road map to thinking through them carefully.
Public Data and Accountability Intuitively, it makes sense that CRA would increase lending to communities, as it requires banks to meet community credit needs,
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particularly in low- and moderate-income (LMI) communities, that are consistent with safety and soundness. Under CRA, federal examiners assess banks’ lending, investment, and services in LMI communities and then give them ratings using publicly available data. Anyone from the public can comment on a bank’s CRA record with the intention of influencing the examiner’s grade. This system of accountability should prompt a bank to make more loans, investments, and services to LMI communities than they may otherwise. As I often say when I give presentations, imagine if your report cards were posted on the Internet—would you work harder to improve your grades? I certainly would. Intuition must always be backed up by data analysis, and four articles in the HUD volume do just that. Bostic and Lee use a regression discontinuity design to document that CRA small business lending increases to a greater extent in moderate-income census tracts that are eligible for CRA consideration compared to middle-income census tracts that have income slightly over the CRA limit--which is a little higher than 80 percent of area median income. (Bostic & Lee, 2017). This study is important not only because it is one of the few to use CRA small business data, but it also indicates that the “CRA effect” was stronger in the years preceding the financial crisis than in years during the crisis. The financial crisis increased unemployment and depressed incomes, particularly for low- and moderate-income people. Hence, CRA’s effectiveness diminished during the crisis. Policymakers’ goal should be to prevent huge, gain-erasing busts in the future by enacting sensible policies and laws. Like Bostic, Ding and DeMaria of the Philadelphia Federal Reserve Bank (2017) employed a similar methodology and found that CRA boosts lending by 10 percent in census tracts eligible for CRA (this
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study is not in the Cityscape publication but came out around the same time). Butcher and Munoz also apply regression discontinuity design more generally to all types of lending using data from Equifax, and have findings consistent with Bostic and Lee (2017). Importantly, Butcher and Munoz find that there is no difference in delinquency rates in census tracts that are CRA eligible compared to those that are not. This is yet another of several studies debunking the myth that CRA pushes banks to make risky loans in order to serve LMI borrowers. Despite the claims of its critics, CRA requires banks to make safe and sound loans; the evidence overwhelmingly demonstrates that banks and the regulatory agencies enforcing CRA have held true to this statutory requirement. CRA encourages community group and bank dialogue and partnerships, which have increased lending to traditionally underserved communities. Casey, Farhat, and Cartwright find that when banks and community groups negotiate CRA agreements committing banks to specific increases in future lending, the lending to underserved communities increases in a statistically significant manner (2017). The Metropolitan St. Louis Equal Housing Opportunity Council (EHOC) formed a coalition of groups, the St. Louis Equal Housing and Community Reinvestment Alliance (SLEHCRA) in 2009, which has since negotiated 46 agreements. Casey, et al. find that since the formation of SLEHCRA and its agreements, lending has increased in underserved communities and in particular to African-American borrowers. The spur of CRA-related activism motivates banks to work in partnership with community-based organizations to develop specific products and programs to serve borrowers outside of the financial mainstream. Quercia and Riley report on the experience of the Self-Help Credit Unionâ&#x20AC;&#x2122;s Community Advantage Program
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(CAP) that relaxed traditional underwriting criteria and resulted in 46,000 loans issued over the last couple of decades to borrowers with credit profiles that made them targets of subprime lenders in the early- to mid-2000s (2017). They document that responsible lending programs like CAP performed much better than subprime lending with high default and delinquency rates, but acknowledge that the delinquency rates of programs like CAP are higher than traditional prime lending. With careful planning and capital reserve practices, banks and secondary market institutions like Fannie Mae and Freddie Mac can bring these programs to scale. One important question that Quercia and Riley did not attempt to answer in their piece is how much CRA lending can occur without underwriting flexibilities, subsidies, and higher reserves. In other words, there are many different subgroups within the LMI population, including those with shakier credit, but also those with no credit issues who happen to fall outside the financial mainstream. How much lending needs to be like CAP and how much lending can be just regular prime lending made more accessible? Answering this question will do much to introduce more light and less heat into the discussion. The Cityscape volume, in an attempt at balance, provided space for a CRA critic, but misfires badly. Yezer of George Washington University contradicts himself when he says that “…economists have been unsuccessful in determining that having institutions with high CRA ratings makes a significant difference in overall economic performance” (2017). Later in the article, however, he blames CRA for contributing to unsustainable housing bubbles by “encouraging banks to make loans even in areas where housing prices threaten housing affordability” (2017). So, let’s get this straight: CRA cannot take credit for contributing to positive economic development, but can only effectively intervene at the city or neighborhood level to exacerbate negative trends like rapid housing value appreciation? If CRA has not contributed to
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local economics, then it is likely that it has had neither good nor bad impact (rather than just bad). The truth of the matter probably lies more closely with Bosticâ&#x20AC;&#x2122;s and others articles, which demonstrate that CRA spurred increases in safe and sound lending. This would be the case particularly in instances of market failure in which banks and/or consumers lack information that inhibit lending. The findings of CRA lending jumping in census tracts near the CRA income level boundary suggest that lenders are making more of an effort to overcome barriers to lending in neighborhoods just under the CRA income level boundary. Moreover, if there are concerns with banks lending in overheated markets, stretching their underwriting criteria to make risky loans in order to pass their CRA exams, or otherwise engaging in other problematic practices, CRA examiners are supposed to take this into account when rating the banks. If CRA examiners were not taking these practices into account, this would not be the failure of the CRA regulation or statute that mandates safe and sound lending. It would be a failure on the part of the CRA examiners and their agencies. While there have been instances of lax CRA examination, the record of CRA suggests that preserving safety and soundness has not been a pressing concern with CRA implementation. Yezer advances arguments that must be addressed but then he makes assertions without rigorous data analysis.
The Future and Fintechs-A Moving Regulatory Target In addition to the articles and studies that review CRAâ&#x20AC;&#x2122;s impact, several other articles explore how CRA must evolve to keep pace with industry developments. On top of everyoneâ&#x20AC;&#x2122;s list in the fair lending arena is how CRA, or a law or regulation like CRA, can cover fintechs.
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Fintechs are financial technology companies that do not lend through branches, but over the Internet. CRA is a branch-based law, which is implemented by examining lending in geographical areas covered by branches. As more fintechs, and even regular banks, make more loans outside traditional branch networks, how can a CRA framework assess such lending? Gaughan explores this question and rightfully insists on objective measures of performance, but is vague on whether fintechs should be held to performance on a national level, by region, or some other geographical area (2017). Since redlining is a local phenomenon that CRA sought to overcome, the National Community Reinvestment Coalition (NCRC) insists that all lenders, even ones on the Internet, be held accountable for safe and sound local lending. As more fintechs apply for bank charters, letâ&#x20AC;&#x2122;s take a pragmatic approach and see if geographical examinations of their performance can occur. Social Finance (SoFi), for example, said in its application for a bank charter that it does the majority of its business in the ten largest metropolitan areasâ&#x20AC;&#x201D;so letâ&#x20AC;&#x2122;s hold them accountable for reaching underserved populations in these areas. NCRC will seek to determine through data analysis of lending concentrations and dialogue with fintechs what ways we can hold them accountable to local communities. Immergluck explores how the new Affirmatively Furthering Fair Housing rules promulgated by HUD compares to CRA in terms of ease and effectiveness of implementation (2017). The AFFH rules require local jurisdictions to develop plans based on data analysis that identify and seek to rectify patterns of segregation that ultimately retard local economies by diminishing opportunities for minorities to seek quality housing and jobs. Immergluck hints that it may be harder to implement AFFH more rigorously than CRA (2017). Another line of inquiry that NCRC is pursuing is how practitioners and policymakers can get AFFH and CRA working together, namely, how can stakeholders work with
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banks, cities, and counties to encourage banks to make CRA-related loans and investments to LMI borrowers in a manner that promotes integration? Lastly, three articles (Bull, Willis, and Silver) address how improving the use of data and public input is vital to strengthening the impact of CRA. Willis discusses how banksâ&#x20AC;&#x2122; home lending is compared against demographic benchmarks (2017). CRAâ&#x20AC;&#x2122;s income definition usually targets 40 percent of households whose income is LMI or 80 percent or less of median income. Is it reasonable to expect banks to make 40 percent of their loans to LMI households, thereby matching their percent of the population? Willis suggests it is not reasonable because a segment of lower income households simply cannot afford homeownership. While I may not agree with Willisâ&#x20AC;&#x2122; exact methodology and have used other methodology in the past to develop a reasonable demographic benchmark, he poses a fair question that requires thoughtfulness. It is also important to remember that CRA is not only about homeownership but also about meeting credit needs for affordable rental housing, small business development, and community facilities for LMI consumers and communities. Bull tackles the issue of how community development corporations (CDCs) and other local nonprofits can use CRA (2017). The answer is with great difficulty. When students working on behalf of CDCs tried to ask branch personnel for CRA exams, they received either defensive answers or blank stares. When students tried using CRA exams to identify local community development loans or investments in housing or small businesses in neighborhoods served by the CDCs, they were unable to do so. Since CRA is designed to respond to local needs, thwarts to such efforts also thwart its purpose. NCRC has advocated for community development loan and investment data on the census tract level so that community-based
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organizations can better track bank records of local neighborhood investment. At the very least, if not in CRA exams, the bank CRA public files ought to contain lists of community development projects organized by neighborhood or census tract. Lastly but not least, Silver (the author) has a piece emphasizing that though CRA should and must be all about public participation (2017), it sure doesn’t feel that way. Following up on Bull’s angle, I examine the extent to which CRA and the related bank merger application process encourages public input or places obstacles to input. To answer that question, I ask the readers of this blog whether they tried to figure out how to comment on CRA exams (it is very difficult to do so unless you work at an organization like mine). The merger application process is more advanced in this regard, meaning that the agencies can improve the CRA examination process by picking up on techniques and lessons learned from the merger application process. In addition, I also examine how out-of-date examination procedures that include the geographical areas on CRA exams (reminiscent of the fintech discussion above) impede public participation—why participate if your smaller city or rural area does not really factor on CRA exams? All is not hopeless, however, as I suggest pragmatic fixes that do not involve Congress or the agencies rewriting CRA regulations. The federal bank agencies are in the process of updating their examination procedures, and it is hoped that they will adopt some of NCRC’s recommendations such as improving geographical coverage on CRA exams. In other words, NCRC believes that reforming CRA can be done in a practical way that does not involve lengthy regulatory rulemaking or Congress passing amendments to CRA. President Trump issued an executive order requiring interagency review of the impacts of a wide array of regulations including banking regulations. The Treasury Department already issued a report that a previous blog of mine reviewed. Treasury indicates
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that it will take a serious look at CRA in the fall, and we will be urging Treasury to look carefully at the evidence of CRAâ&#x20AC;&#x2122;s effectiveness as well as the thoughtful pieces in the Cityscape issue on CRAâ&#x20AC;&#x2122;s 40th Anniversary. The genius of CRA is that it is not a top-down mandate by the government. Instead, it establishes a process for measuring bank reinvestment performance and a dialogue among banks, the community, and the regulatory agencies on how to improve bank reinvestment performance. If the Trump administration takes steps to broaden this dialogue, the result will be more responsible loans and investments in communities. If the administration shortchanges or stifles this dialogue and appoints heads of federal banking agencies that weaken CRA, it will not succeed in creating the jobs and prosperity that the president says is his goal.
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Bostic, R. W., & Lee, H. (2017). Small Business Lending Under the Community Reinvestment Act. Cityscape: A Journal of Policy Development and Research @BULLET, 19(2). Retrieved from https://www.huduser.gov/portal/periodicals/cityscpe/vol19num 2/ch6.pdf Bull, M. (2017). Cityscape Data, Accountability, and the Public: Using Community Reinvestment Act Data for Local Community Development. Cityscape: A Journal of Policy Development and Research @BULLET, 19(2). Retrieved from https://www.huduser.gov/portal/periodicals/cityscpe/vol19num 2/ch11.pdf Butcher, K. F., MuĂąoz, A. P., & Faro, G. (2017). Using Credit Reporting Agency Data To Assess the Link Between the Community Reinvestment Act and Consumer Credit Outcomes. Cityscape: A Journal of Policy Development and Research @BULLET, 19(2). Retrieved from https://www.huduser.gov/portal/periodicals/cityscpe/vol19num 2/ch7.pdf Casey, C., Farhat, J., & Cartwright, G. (2017). Community Reinvestment Act and Local Governance Contexts: Advancing the Future of Community Reinvestment? Cityscape: A Journal of Policy Development and Research @BULLET, 19(2). Retrieved from https://www.huduser.gov/portal/periodicals/cityscpe/vol19num 2/ch10.pdf Ding, L., & Demaria, K. (2017). The Effects of the Community Reinvestment Act (CRA) on Mortgage Lending in the Philadelphia Market. Federal Reserve Bank of Philadelphia. Retrieved from https://philadelphiafed.org//media/community-development/publications/discussion-
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papers/practitionersummary_the_effects_of_the_community_reinvestment_act_o n_mortgage_lending_in_the_philadelphia_market.pdf?la=en Durbak et al. (2017). Cityscape Symposium Habitat III. Cityscape. Washington DC: Office of Policy Development and Research of the U.S. Department of Housing and Urban Development. Retrieved from https://www.huduser.gov/portal/periodicals/cityscpe/vol19num 2/index.html Essene, R. S et al. (2009). Revisiting the CRA: Perspectives on the Future of the Community Reinvestment Act. Federal Reserve Banks of Boston and San Francisco. Retrieved from http://www.frbsf.org/communitydevelopment/files/revisiting_cra.pdf Gaughan, M. (2017). Commentary: FinTech and the Liberation of the Community Reinvestment Act Marketplace. Cityscape: A Journal of Policy Development and Research @BULLET, 19(2). Retrieved from https://www.huduser.gov/portal/periodicals/cityscpe/vol19num 2/ch13.pdf Immergluck, D. (2017). Commentary: Encouraging Housing Equity. Cityscape: A Journal of Policy Development and Research @BULLET, 19(2). Retrieved from https://www.huduser.gov/portal/periodicals/cityscpe/vol19num 2/ch9.pdf Quercia, R. G., & Riley, S. (2017). Bridging the Gap to Scalable Community Reinvestment Lending Programs. Cityscape: A Journal of Policy Development and Research @BULLET, 19(2). Retrieved from
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Silver, J. (2017). Commentary: The Community Reinvestment Act Must Be All About Public Participation, but It Still Doesnâ&#x20AC;&#x2122;t Feel That Way. Cityscape: A Journal of Policy Development and Research @BULLET, 19(2). Retrieved from https://www.huduser.gov/portal/periodicals/cityscpe/vol19num 2/ch12.pdf Willis, M. A. (2017). Commentary: Filling a Gap in the Community Reinvestment Act Examiner Toolkit. Cityscape: A Journal of Policy Development and Research @BULLET, 19(2). Retrieved from https://www.huduser.gov/portal/periodicals/cityscpe/vol19num 2/ch15.pdf Yezer, A. (2017). Commentary: What Can We Learn From Government Attempts To Modify the Allocation of Mortgage and Consumer Credit in the United States? Cityscape: A Journal of Policy Development and Research @BULLET, 19(2). Retrieved from https://www.huduser.gov/portal/periodicals/cityscpe/vol19num 2/ch14.pdf
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Key Stakeholders Explain the Difference Between M-Pesa’s Success in Kenya and Failure in South Africa By Karl M.F. Lockhart Abstract M-Pesa is a mobile payment product that was launched in Kenya in 2007. It enables users to pay for goods and services and transfer money amongst themselves without needing a bank account. This paper will describe M-Pesa’s success in Kenya and failure in South Africa as well as provide a brief explanation of what M-Pesa is and how it works. Discussion will then turn to an analysis of key stakeholders—including consumers, competitors, and regulators— to aid in understanding the difference in outcomes between the two countries. Finally, this paper will examine other potential factors that could have contributed to the variance in results.
I. Introduction M-Pesa is a mobile payment product that was launched in Kenya in 2007 by Safaricom, a Kenyan subsidiary of global telecommunications provider Vodafone. It enables users to pay for goods and services and transfer money amongst themselves without needing a bank account. Although wildly successful in Kenya in terms of number of users and volume of transactions, consumers’ response to the product in South Africa was underwhelming, and Vodacom (the South African subsidiary of Vodafone) was forced to pull the product. This paper will describe M-Pesa’s success in Kenya and failure in South Africa, as well as provide a brief explanation of what M-Pesa is and how it works. Discussion will then turn to an analysis of key stakeholders—including consumers, competitors, and regulators—to aid in understanding the difference
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in outcomes between the two countries. Finally, this paper will examine other potential factors that could have contributed to the variance in results.
II. Success: The Product in Kenya A. Implementation The story of M-Pesa begins with the story of cell phones in Africa. As of 2002, only one in 10 Kenyans owned a cellphone (Pew Research Center, 2015). Within a decade, this figure had risen meteorically to 82% (Pew Research Center, 2015). In addition, 58% of those who did not own a cell phone said that they shared one with someone else, putting the number of those with access to a cellphone closer to 90% (Pew Research Center, 2015). This is especially true since individuals who own a SIM card can switch it in and out of a shared phone (Graeber, 2014). With cell phone use rising so rapidly, airtimeâ&#x20AC;&#x201D;credit purchased to be able to text, talk, and use data on a mobile phoneâ&#x20AC;&#x201D;quickly became a valuable and tradable commodity. When researchers for a British development agency saw that Kenyans were electronically sending each other airtime in lieu of money to facilitate transactions, they realized that mobile money could be a successful innovation (Runde, 2015). After applying for a grant and creating a public-private partnership, Safaricom initiated a promising pilot project and eventually rolled out M-Pesa across Kenya (Proudly Made, 2014). Ten years after its 2007 launch in Africa, the value of M-Pesa deposits was equivalent to over 1.2 billion in United States dollars. M-Pesa had facilitated over 237 million transactions and over 62% of Kenyans counted among mobile-money users (Safaricom, 2015; Runde, 2015; McKay & Mazer, 2014).
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B. Product Design and User Experience To register for M-Pesa, users must simply buy a Safaricom SIM card and register with their national identification number (the equivalent of a Kenyan passport number) (Jack & Suri, 2011). Safaricom boasts that it has over 40,000 vetted and trained sales agents countrywide, so finding a place to purchase a SIM card and register it is not difficult (Safaricom, 2017).3 Once an account has been set up, users give cash to the agent in exchange for “e-float.” “E-float” is a commodity with a one-to-one equivalence of cash in the user’s M-Pesa account (Jack & Suri, 2011). Users can then send money via text to anyone else with an M-Pesa account to pay for nearly anything, e.g., taxi ride, coffee, meals, domestic airplane tickets (Graeber, 2014). Those who send money are charged based on a sliding scale that depends on how much money they send and whether or not they are sending the money to a registered user (Mpesa Rates, 2017). Those who receive money are not charged; however, there is again a sliding scale to withdraw money from one’s M-Pesa account (Jack & Suri, 2011). There is no charge to deposit money, which encourages savings (Jack & Suri, 2011). The cash received in exchange for “e-float” is held by a trust owned by Vodafone, the company with a managing stake in Safaricom, across several banks to diversify risk (McKay & Mazer, 2014). M-Pesa has expanded its services from peer-to-peer transactions. Since its launch in 2007, more features have been added, including the ability for users to withdraw money from ATMs and pay utility bills (Mas & Radcliffe, 2011; Olopade, 2014). Now, with the introduction of M-Shwari (a partnership with Commercial Bank of Africa), Kenyans have access to a slew of banking products, including short-term loans and savings accounts that pay up to five percent interest (Cook & McKay, 2015). In addition, M-Pesa has 3
Agents make a commission based on a percentage of the value of the transactions they facilitate (Jack & Suri, 2011).
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opened its Application Programming Interface (API) to developers, in the hopes that an entire ecosystem of apps can be created around the product (Kamau, 2016). Most recently, charges were abolished on transactions less than 100 Kenyan shillings, making the product more accessible for the poor (Nairobi News, 2016). C. Benefits Why have consumers in Kenya flocked to M-Pesa? One of the primary reasons is that carrying large amounts of cash over long distances can be dangerous (Jack & Suri, 2011). With M-Pesa, users can transfer money without incurring the risks of robbery or forced bribes. Bribes are often paid to government officials or police officers, who consumers encounter in day-to-day interactions, in order to avoid arbitrary arrest, a notorious problem in Kenya (Graeber, 2014). In addition, domestic remittances—often from family members who moved to urban areas for work sending money to those in the rural countryside—are much easier to execute with M-Pesa (Mas & Radcliffe, 2011). M-Pesa is also especially useful for those who do not have a bank account or live far from bank branches (Vodafone Group, 2016b). Finally, M-Pesa is much cheaper than other non-cash means of transferring money, such as Western Union (Jack & Suri, 2011).
III. Failure: Launch in South Africa Bob Collymore, the CEO of Safaricom who was instrumental in the launch and success of M-Pesa in Kenya, recently stated his goal that M-Pesa “be [just] like Whatsapp” in its ubiquity across Africa (Dahir, 2016). Unfortunately, that has yet to occur. Although the service is now present in 10 countries, including seven African countries, success has been lacking in two of Africa’s largest markets, Nigeria and South Africa (Vodafone Group, 2016a). South Africa has been a particularly problematic location for M-Pesa.
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Vodacom—the South African subsidiary of Vodafone and a sister company of Safaricom—expanded M-Pesa to South Africa in 2010, in the hopes of reaching 10 million users by 2015. However, there were only one million users by 2015, and less than a tenth of them were considered active. This shortfall in users was despite a massive “relaunch” in 2014, when Vodacom partnered with a new bank and added new and improved services (Murori, 2016; Mondato, 2016; Chutel, 2016). Vodacom finally pulled the plug on its struggling foray into South Africa in June 2016 (van Zyl, 2016). Pundits have posited many theories to attempt to explain the difference between the sweeping success of M-Pesa in Kenya and its unmitigated demise in South Africa. Although various factors have been mentioned, none seems conclusive. This paper argues that key stakeholders—consumers, competitors, and regulators— help to explain the divergent outcomes.
IV. Key Stakeholders Explain the Difference in Outcomes A. Consumer Preferences First and foremost, Kenyan and South African consumers were not alike. Kenyan consumers had a much lower level of access to financial services prior to M-Pesa than South African consumers did. In 2006, only 19% of Kenyans had access to financial services, while the percentage of South Africans who had a bank account had been increasing sharply even before M-Pesa’s arrival and had reached approximately 70–75% by the time of M-Pesa’s exit from South Africa (British High Commission Nairobi, 2013; Mondato, 2016). In other words, South Africans did not use M-Pesa because they had no need for it—they could already save, withdraw, and borrow money with ease. Indeed, a senior Vodacom executive attributed M-Pesa’s failure in South Africa to the fact that South Africans preferred credit cards to mobile money (Murori, 2016).
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In short, Vodacom did not adequately tailor its product to a new market. Though financial innovations such as M-Pesa can be effective in the right contexts, they can easily falter without a clear vision of the end user. While Kenyan consumers desperately needed a way to transfer money safely, the majority of South Africans had and were familiar with banking products and services and did not need the features that M-Pesa provided. Failing to account for these consumer preferences cost Vodacom dearly on a purely financial basis. The unsuccessful endeavor in South Africa also represented a significant opportunity cost, as Vodacom could have used employees’ time and effort to venture into another market where MPesa could have been more profitable and consumers more in need of the service it provides. B. Competition from Established Banks Competition also may have played a significant role in the different levels of success in each country. Safaricom was by far the largest mobile carrier in Kenya, with nearly an 80% market share at the time M-Pesa was launched (Jack & Suri, 2011). Consumers knew the company and trusted it to handle their money (Tech Central, 2016). In South Africa, on the other hand, the “big four” banks— Standard Bank, FnB, Nedbank, and ABSA—control nearly 90% of the retail banking market. Yet, in its 2014 re-launch, Vodacom partnered with Bidvest, a South African bank that was not one of the “big four.” Furthermore, Bidvest was not well known among the poor and socially-disadvantaged sectors of society, M-Pesa’s target demographic. (Mondato, 2016). Although banking institutions and telecom providers are not often considered competitors, rapid technological advances have allowed firms to create products that cross over into new sectors. Companies that were dominant in one location in a new sector may not find the same level of success in other locations if that sector is more highly developed there. South Africa’s banks are well-established, strategic players that knew how to handle the entrance of a new
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competitor. Although it had brand recognition and a respectable piece of the South African telecoms market, Vodacom did not fully account for the difference between the strengths of Kenya’s and South Africa’s banks. In short, the dominance of competitors in the banking sector, along with miscalculations regarding consumers and regulators, contributed to M-Pesa’s failure in South Africa. C. The Governmental-Regulatory Environment The competition issue addressed above is strongly connected to the level of regulation M-Pesa faced in each country. In Kenya, regulators took a hands-off approach, quite possibly because they knew and trusted Safaricom (McLeod, 2016). It is also likely that Safaricom had deep relationships with government officials in Kenya and was able to influence regulation. In South Africa, however, laws were passed that required Vodacom to partner with a South African bank, even though many of the local banks were already developing their own mobile payments system. This inherent conflict is possibly what led to Vodacom’s first partnership with Nedbank to fall through (Mondato, 2016). The banks’ power to shape South African legislation put up a major roadblock for MPesa’s success that came in the form of stringent regulation. In addition, new users of M-Pesa in South Africa had to comply with nearly the same requirements as setting up a bank account–, which isa much higher bar to clear than the one in Kenya, where all that was required was a phone number and national ID (Mondato, 2016). These strict requirements prevented many foreign migrant workers living in South Africa from setting up M-Pesa accounts, cutting out a significant market, since M-Pesa would have been a highly cost-effective way for these workers to send money back home (Mondato, 2016). Again, more stringent legal requirements in South Africa blocked M-Pesa from being as successful there as it was in Kenya.
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Both of these examples point to the power of the regulator to influence the adoption of a new product. When an innovation is viewed with skepticism—rightly or wrongly—the government’s ability to limit access to the product through rules and mandates can substantially decrease demand. As such, along with consumers and competitors, regulators should not be left out of the equation of key stakeholders when launching a new product in a new location.
V. Conclusion This paper has analyzed key stakeholders to explain M-Pesa’s divergent outcomes in Kenya and South Africa. By analyzing consumers, competitors, and regulators, this paper offers a clearer understanding of why M-Pesa succeeded in one country and failed in the other. However, operational and timing differences may have also played a role in the divergent results. In Kenya, M-Pesa was launched directly after electoral violence had taken place, which caused chaos and uncertainty about whether traditional methods of money transfer would work in times of crisis (van Zyl, 2016; McLeod, 2016). M-Pesa was the perfect antidote to that fear: the ability to send money instantly, with only the need for a cellphone signal. In this way, the timing of M-Pesa’s debut in Kenya played a role in its success. Similarly, operational miscalculations in the South African rollout of M-Pesa contributed to the lack of traction. Vodacom only had about 800 of its own sales agents ready to facilitate M-Pesa transactions for its initial launch in South Africa; even for the 2014 relaunch, the 8,000 M-Pesa sales agents spread across South Africa paled in comparison to the nearly 150,000 sales agents spread across both Kenya and Tanzania at the time (Mondato, 2016). While these factors may not have been as critical as those described above, they no doubt contributed to the disparate outcomes.
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What different results could have occurred if Vodacom had better analyzed key stakeholders? With regard to competition from banks, it may have been wiser to license the rights to the use of M-Pesa technology in South Africa to one of the big four banks and let that bank roll out the product. Whichever bank purchased the license could then have used its expertise and consumer trust to successfully build up its client base and, as an added benefit, would not have had to develop a mobile-money product of its own. It is also possible that M-Pesa would never have been a success in South Africa regardless of how it was packaged, since South Africa and Kenya are vastly different countries. Foresight and sensitivity to the interests of stakeholders within countries can help avert adverse outcomes.
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British High Commission Nairobi. (2013, November 3). Report on financial access in Kenya launched. Retrieved from https://www.gov.uk/government/world-locationnews/report-on-financial-access-in-kenya-launched Cook, T., & McKay, C. (2015, April). How M-Shwari Works: The Story So Far. Access to Finance Forum, 10. Retrieved from http://www.cgap.org/sites/default/files/Forum-How-MShwari-Works-Apr-2015.pdf Chutel, L. (2016, May 9). Vodacom has given up on revolutionary mobile money service M-Pesa, in South Africa. Retrieved from http://qz.com/679059/vodacom-has-given-up-onrevolutionary-mobile-money-service-m-pesa-in-southafrica/ Dahir, A. L. (2016, October 20). The CEO of Africa’s most innovative mobile company warns his “clumsy” product needs to diversify or risk dying. Retrieved from http://qz.com/813612/bob-collymore-safaricom-ceo-warnsm-pesa-is-a-clumsy-product-that-needs-to-diversify-or-riskdying/ Graeber, C. (2014, June 9). Ten Days in Kenya With No Cash, Only a Phone. Retrieved from http://www.bloomberg.com/news/articles/2014-0605/safaricoms-m-pesa-turns-kenya-into-a-mobile-paymentparadise Jack, W., & Suri, T. (2011, January). The Economics of M-Pesa. Retrieved from http://www.nber.org/papers/w16721 Kamau, M. (2016, November 8). Collymore bets on opening up MPesa to ring up Safaricom’s future billions. Retrieved from
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http://www.standardmedia.co.ke/business/article/200022263 2/collymore-bets-on-opening-up-m-pesa-to-ring-upsafaricom-s-future-billions/ Mas, I., & Radcliffe, D. (2011, August). Mobile Payments go Viral: M-PESA in Kenya. Journal of Financial Transformation, 32, 169-182. Retrieved from https://papers.ssrn.com/sol3/papers.cfm?abstract_id=159338 8 McKay, C., & Mazer, R. (2014, October 1). 10 Myths About MPESA: 2014 Update. Retrieved from http://www.cgap.org/blog/10-myths-about-m-pesa-2014update McLeod, D. (2016, June 5). Why M-Pesa â&#x20AC;&#x2DC;will never work in South Africa.â&#x20AC;&#x2122; Sunday Times. Retrieved from http://www.timeslive.co.za/sundaytimes/businesstimes/2016 /06/05/Why-M-Pesa-will-never-work-in-South-Africa Mondato. (2016, July 26). Third Time's Not a Charm: M-Pesa's South African Flop. Retrieved from http://blog.mondato.com/m-pesa-south-africa-flop/
Mpesa Rates. (2017). Mpesa Charges 2017 from Safaricom. Retrieved from http://www.mpesarates.com/mpesa-chargessafaricom/ Murori, K. (2016, May 11). M-Pesa Fails in South Africa for The Second and Possibly Last Time. Retrieved from https://www.africanexponent.com/post/mpesa-fails-in-safor-the-second-and-possibly-last-time-3027
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Nairobi News. (2016, November 4). Safaricom Abolishes Charges for Lower M-Pesa Transactions. Retrieved from http://nairobinews.nation.co.ke/news/safaricom-abolishescharges-lower-m-pesa-transactions/ Olopade, D. (2014, May). Africaâ&#x20AC;&#x2122;s Tech Edge. The Atlantic. Retrieved from https://www.theatlantic.com/magazine/archive/2014/05/afric as-tech-edge/359808/ Pew Research Center. (2015, April 15). Cell Phones in Africa: Communication Lifeline. Retrieved from http://www.pewglobal.org/2015/04/15/cell-phones-in-africacommunication-lifeline/ Proudly Made in Africa. (2014). M-Pesa: The Safaricom Story. Retrieved from http://www.proudlymadeinafrica.org/images/uploads/docs/ M-Pesa_CaseStudy_June14_synopsis.pdf, at 1-3. Runde, D. (2015, August 12). M-Pesa and the Rise of the Global Mobile Money Market.. Retrieved from http://www.forbes.com/sites/danielrunde/2015/08/12/mpesa-and-the-rise-of-the-global-mobile-money-market/ Safaricom. (2015, December 31). Celebrating 9 Years of Changing Lives. Retrieved from http://www.safaricom.co.ke/mpesa_timeline/timeline.html Safaricom. (2017). Experience M-Pesa: Agent Locations. Retrieved from http://www.safaricom.co.ke/personal/m-pesa/getstarted-with-m-pesa/m-pesa-agents van Zyl, G. (2016, May 9). Why Vodacom M-Pesa has flopped in SA. Retrieved from
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http://www.fin24.com/Tech/Companies/why-vodacom-mpesa-has-flopped-in-sa-20160509 Vodafone Group. (2017). M-Pesa. Retrieved from http://www.vodafone.com/content/index/what/m-pesa.html Vodafone Group. (2017). M-Pesa FAQs. Retrieved from http://www.vodafone.com/content/index/what/m-pesa/mpesa-faqs.html Tech Central. (2016, May 17). Why M-Pesa works in Kenya but not SA. Retrieved from https://www.techcentral.co.za/why-mpesa-works-in-kenya-but-not-sa/65326/
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Enhancing U.S. Power through Sound Financial Regulation: How Wall Street Reforms Can Defend American Hegemony By George E. Rudebusch Introduction Strong national security is dependent on having a strong diplomatic arm, a strong development arm, a strong intelligence arm, a strong capability to try to have [a] strong econom[y] in the world…[A]ll of this is related to our national security. And I think if any one of these areas suffers…it’s going to damage our security by virtue of the kind of broad approach we need to have…to maintain the leadership position we have in the world. – Former Secretary of Defense Leon Panetta (2012) The United States projects power with its vibrant economy. American diplomats and members of our armed forces rely on our world-leading economy to secure our national interests abroad. 4 As the former Secretary of Defense Leon Panetta rightly suggests, a 4
By many accounts, the Chinese economy will soon, or has already, surpassed the U.S. economy as the world’s largest. In its 2016 global economic league table, the Centre for Economics and Business Research (CEBR) noted that while the United States has the largest economy in terms of gross domestic product (GDP), the Chinese economy will overtake the U.S. economy on this measure in 2029 (“World Economic League Table 2016 Highlights”). Once GDP is adjusted to reflect purchasing power parity (PPP), China’s economy has grown larger than the U.S. (“GDP ranking, PPP based”). Nevertheless, the United States still controls a substantial amount of global economic resources. In 2016, the U.S. GDP accounted for 24 percent of global output (Willige, 2016). Adjusted for PPP, the $18 trillion U.S. economy comprised 16 percent of the world total (“GDP ranking, PPP based”).
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large, robust, and diverse economy is a sine qua non for international leadership. The globalized twenty-first century world relies on the United Statesâ&#x20AC;&#x2122; economy. Yet, the U.S. economy is vulnerable to a systemic economic crisis akin to the Great Depression of the 1930s and the Great Recession of the late 2000s. Recent restrictions on the emergency lending authority of the Federal Reserve and the ability of the Federal Deposit Insurance Corporation (â&#x20AC;&#x153;FDICâ&#x20AC;?) to guarantee qualifying secured debt have increased the susceptibility of runs on short-term liabilities in U.S. financial markets. Furthermore, policymakers have less latitude now than in 2008 to use monetary and fiscal policy to arrest the vicious cycle of runs before the entire economic system succumbs to a contagion. While a moderate crisis is less likely today, Wall Street reform coupled with less room for monetary and fiscal policy increases the likelihood of an extreme economic crisis. Systemic crises are, of course, calamitous domestic events. They create substantial hardships, including mass unemployment, widespread foreclosures on homes, and vast erosions of wealth. Of equal importance, though oft-neglected, extreme economic crises raise numerous national security threats. They sap resources, hampering the United States from adequately funding its multifaceted and engaged leadership in global affairs. They also redirect the attention of national leaders away from international issues and back to the home front. As a consequence, economic crises present ripe opportunities for foreign adversaries to exploit. Of particular note, they leave the U.S. vulnerable to economic assaults. Many nations hostile to America hold U.S. assets valued in the trillions of dollars. If these adversaries unloaded their holdings at the depths of a severe crisis, the U.S. economy could further spiral and suffer significant, perhaps even irreparable, damage. This threat is not imagined; in fact, adversaries have made such attempts in the past. During the 2008 financial crisis, for example, Russia
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attempted to collude with China to launch such an attack on U.S. markets (Rothkopf, 2014; Peston, 2014). The federal government needs preventative and palliative economic tools to reduce our domestic and national security vulnerabilities uncovered during systemic economic crises. In 2010, Congress passed the Dodd-Frank Wall Street Reform and Consumer Protection Act (“Dodd-Frank”) to equip the government with these very tools. While the law succeeds in many respects, it has ultimately left the United States more susceptible to economic contagions. Therefore, Dodd-Frank needs reform. In doing so, the United States will enjoy enhanced economic security, and thus enhanced national security as well. Incontrovertibly, Dodd-Frank reform is in the national interest. In this essay, I expand on this argument. The following section details the theory of extreme economic crises. This section also provides a brief account of the 2008 financial crisis and the national security risks it posed. Section II presents an overview of DoddFrank, noting three successes particularly germane to economic security and thus to the national interest. Section III argues that two restrictions under Dodd-Frank—on the lending authority of the Federal Reserve and on the ability of the FDIC to guarantee certain debt—need repeal. Both restrictions leave the U.S. economy more vulnerable to financial contagions. Section IV considers an additional reform measure, one not directly related to Dodd-Frank. This third and final component to the reform package I propose advocates for the expansion of asset classes the Federal Reserve can purchase through open-market operations. This new monetary policy would equip the central bank with a powerful tool to prevent a moderate contraction from devolving into a systemic crisis. Section V projects the effects of the reform package on various parties to the U.S. economy, as well as how these protect and further U.S. foreign-policy interests. I conclude in section VI by offering a novel advocacy strategy to ensure the timely passage of the proposed Dodd-Frank reforms.
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Theory and History of Financial Contagions Modern finance is an engine for growth. Fundamentally, financial institutions provide maturity transformation to economies. Through this process, these institutions fund relatively risky, illiquid longterm assets, such as home mortgages and commercial loans, with less risky, liquid short-term liabilities, such as cash deposits. Maturity transformation funnels money from people with surplus earnings right now to those who need future income today (“The slumps that shaped modern finance”). The ultimate result is twofold: savers see their unspent income grow over time, and borrowers finance activities that generate additional earnings here and now. Overall, maturity transformation expands the economy, benefitting savers and borrowers alike. Nevertheless, maturity transformation comes with an inherent degree of risk. What if every consumer demands their deposits at the same time? What happens if the long-term assets held by banks suddenly sour? Modern finance has created sophisticated instruments to hedge away some of this inherent risk. Still, a great deal of it always remains in financial markets. The inherent risk of finance becomes particularly perilous “in periods that see both large increases in wealth and optimistic beliefs about the economy,” writes Timothy Geithner (2016, 55), former United States secretary to the treasury during both the Bush and Obama administrations. Such periods flood financial markets with an oversupply of short-term liabilities, which amounts to trillions of dollars in today’s world (Geithner, 2016). With excess cash and money-like equivalents on their balance sheets, banks increase the supply of long-term credit. When credit supplies eventually contract and buoyant economic times end, financial panics often ensue, because short-term liabilities are runnable—“creditors,” the former treasury secretary accurately notes, “can demand their money back at a moment’s notice” (Geithner, 2016, 55).
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The financial crisis of 2008 is the latest example of an economic run, albeit one complicated by complex financial instruments. A steady overprovision of credit and an over-assumption of risk characterized the lax practices of financial institutions during the half-decade following the bursting of the dot-com bubble. Deluded by the times, bankers and financiers relaxed lending requirements and risk-management processes. This inflated home prices; in fact, the average home price in the United States peaked at 125 percent of its value from not even a decade earlier (Rothkopf, 2014). Feeling wealthier, households began to consume beyond their means, leaving them vulnerable to the inevitable downturn. By 2007, the largest financial institutions in the country were overleveraged on low-risk, investment-grade derivatives of highrisk, subprime debt. And because most were nonbank financial institutions, like GE Capital, AIG, hedge funds and governmentsponsored entities (Fannie Mae, Freddie Mac, etc.), many of the firms with the worst investment portfolios escaped regulatory oversight (Rothkopf, 2014).5 With their eyes off the ball, regulators were left exposed to blindsides. And blindsided they were. In late-February of 2007, Freddie Mac issued a press release stating it would stop purchasing mortgages and mortgage-backed securities (Bullard). This cut off the supply of credit for mortgage-lenders and conduits of mortgage-backed securities. By summer, ratings agencies began downgrading bonds secured with subprime mortgages by the dozens. In response, major 5
Nonbank financial institutions are any institution that provides financial services but not registered as a bank (“Nonbank Financial Institutions—Overview”). Common examples include: casinos, broker-dealers, hedge funds, insurance companies, credit card companies, and so on. Even grocery stores that offer check-cashing services, an ancillary function of these businesses, qualify as nonbank financial institutions, which speaks to the diversity of the industry (“Nonbank Financial Institutions—Overview”).
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investment banks, such as BNP Paribas and Bear Stearns, further reduced liquidity in the mortgage market (Bullard). Before ringing in the New Year, the U.S. economy had already become ensnared in a systemic economic crisis on a magnitude not seen since the Great Depression. By now, the story of the fallout from the crash in early 2008 is a familiar one. In the U.S. alone, the financial crisis cost an estimated $648 billion in lost economic activity, about $5,800 in lost income at the household level (Swagel, 2010). Roughly 5.5 million Americans lost their jobs due to a contracting U.S. economy. About 500,000 Americans lost their homes to foreclosure, as well. And then there was the lost wealth. Home values and other real estate in the U.S. lost $3.4 trillion. Losses in stock wealth more than doubled this figure, totaling about $7.4 trillion from July 2008 to March 2009. All told, the financial crisis cost the average U.S. household more than $100,000â&#x20AC;&#x201D;and this estimates merely the financial toll, ignoring social, psychological, and health consequences caused by the Great Recession (Swagel, 2010). A less familiar story about the aftermath of the 2008 financial crisis is the national security risk it posed. According to Hank Paulson, the former United States secretary to the treasury under President George W. Bush, Russia attempted to collude with China to launch a coordinated economic attack on American markets at the depth of the financial crisis in 2008 (Peston, 2014; Rothkopf, 2014). That fall, Fannie Mae and Freddie Mac started to show signs of failure. At the time, Russia and China held a combined $1.7 trillion of mortgage-backed securities issued by the two governmentsponsored enterprises (Peston, 2014). While Secretary Paulson lobbied Congress to approve placing the lending giants into conservatorship, Russia lobbied China to jointly sell Fannie Mae and Freddie Mac securities for cents on the dollar. China, already coping with significant losses from other U.S. investments, refused the Russian offer. Though thwarted in its plan, Russia, Secretary
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Paulson believes, sought “to force the U.S. to use its emergency authorities to prop up [Fannie Mae and Freddie Mac]” (Rothkopf, 2014, 188). And presumably, Russia wanted to inflict maximal damage on the U.S. economy, which was already teetering on the edge of total collapse. Although unsuccessful, the Russian-planned economic assault illustrates that foreign adversaries have at least considered exploiting financial crises as opportunities to damage or perhaps ruin the comparative U.S. economic advantage. Had they held fewer U.S. assets or felt more desperate about their economic future in the depths of the crisis, China may have complied with the Russian plan. If successful, the economic assault could have resulted in billions—or perhaps even trillions—of additional economic costs imposed on the American economy during the crisis. Had this happened and had the U.S. lost its comparative economic advantage, American power would have waned. The foreign policy community recognizes the tremendous value in having the world’s largest economy. Our vast economic resources fund a “ʻrich man’s’ approach to national security” (Nanto, 2011, 5). This strategy combines overwhelming force capabilities with commercial dominance. These assets perpetuate U.S. leadership roles across the globe. They allow U.S. officials to project American values and secure our interests abroad. Such a broad approach to foreign affairs not only requires economic might, but also economic stability. Without a growing, stable economy, our nation cannot sustain our current approach to national security—and likely cannot sustain our global stature (Nanto, 2011). “History”, writes Jacob Lew, former United States secretary to the treasury under President Barack Obama, “has shown that U.S. economic leadership is vital…to the ability of the United States to project its values and achieve its larger foreign policy objectives” (Lew, 2016, 57). If the past is prologue, it is critically important that
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the U.S. ensure its economic vibrancy and stability to maintain its national security interests. No doubt, an extreme economic crisis poses a significant national security threat. To achieve economic security, the U.S. government must take steps to minimize its vulnerabilities. This requires two types of policies. The first attempts to reduce the probability of an extreme economic contagion like the financial crisis of 2008 from ever occurring again. Not only could another extreme crisis ruin our economic superiority by itself, it also presents another opportunity for foreign adversaries to launch an economic assault on U.S. markets. Given our increasingly tense relations, Russia may act on the next opportunity to destabilize American markets. The second type of policies acknowledges the inevitability of economic runs and, as such, authorizes the government to respond to financial crises swiftly and appropriately. The goal here is to return stability to the U.S. economy as soon as possible, dampening crises before they develop into systemic runs. Policymakers are aware of the need for these preventative and palliative economic policies. A case in point, Dodd-Frank took the critical first step toward enacting both types of policies.
Dodd-Frank Successes Dodd-Frank enacted a series of regulatory reforms to ensure that a systemic economic crisis like 2008 never happens again. The drafters of the law also recognized the inevitability and unpredictability of financial crises. Thus, they equipped the government with a broad set of tools to manage crises once they occur. Indeed, despite calls for repeal, Dodd-Frank has generally been quite successful (Geithner, 2017; Sterland, 2017; Baily, Klein &
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Schardin, 2017). Specifically, three measures created by DoddFrank have either decreased the likelihood of a modest crisis or increased the emergency authority of the government to prevent idiosyncratic events from devolving into systemic panics. Higher capital requirements, the first of three “clear wins” under Dodd-Frank with particular relevance to national security, increase Tier 1 capital (i.e., equity and cash reserves) requirements for banks from eight to nine percent to 12 to 14 percent (Baily et al., 2017). Banks use this so-called “core capital” for liquidity when the supply of credit dries up or to absorb losses associated with asset write-offs during market adjustments. Overall, higher capital requirements have added stability to financial markets without imposing macroeconomic costs (Geithner, 2017; Sterland, 2017; Baily et al., 2017). Second, Dodd-Frank implemented a new procedure called singlepoint of entry (“SPOE”) to wind down failing firms. This provision requires that all systematically important financial institutions (“SIFIs”) submit liquidation plans in the event of bankruptcy. In addition to mandating living wills, the SPOE resolution authorizes the FDIC to put a failing SIFI under receivership, liquidate its assets and recapitalize the firm without using taxpayer dollars. The resolution places any losses incurred during recapitalization squarely on the shoulders of shareholders and unsecured debtholders of the SIFI, not the government or taxpayers (Baily et al., 2017). The SPOE provision resolves some uncertainty around the procedure for winding down failing firms. It mitigates some of the moral hazard associated with SIFIs that assume undue risk, knowing they are “too big to fail.” Most important, SPOE reduces the threat of economic contagions: it clears SIFI balance sheets of bad debt and equity, while also providing immediate recapitalization. It is largely believed that SPOE will prove effective at arresting runs in their early stages (Baily et al., 2017).
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The third and final major benefit of Dodd-Frank are new regulations imposed on derivative markets. Previously, these complicated financial instruments traded on opaque over-thecounter markets. A lack of transparency led to information asymmetries, which in turn fueled speculation. In 2007, as the derivative bubble began to pop, the economy began to unravel (Geithner, 2017). After Dodd-Frank, these complicated financial instruments trade on open exchanges, which are far more transparent. Today, derivative markets are much less susceptible to speculation than they were prior to Dodd-Frank (Baily et al., 2017). Taken together, higher capital requirements, the SPOE, and new regulations on derivatives have greatly reduced the risk of modest downturns from occurring. Still, additional measures are necessary to sufficiently ensure American economic security, a necessary condition for our national security.
Repealing Restrictions on the Federal Reserve and the FDIC Paradoxically, Dodd-Frank has left America more vulnerable to an extreme, systemic crisis (Geithner, 2017; Baily et al., 2017). The 2010 law enacted two restrictionsâ&#x20AC;&#x201D;one on the Federal Reserve, the other on the FDICâ&#x20AC;&#x201D;that greatly reduce economic stability. Dodd-Frank banned the Federal Reserve from providing emergency lending to a failing yet solvent financial institution. This important power can prevent idiosyncratic failures of financial institutions. On its own, a single failure might not affect the broader economy. But bank failures are correlated events. Once one bank falls, a domino effect ensues. As the latest crisis proved, the failure of single firm can quickly devolve into a systemic crisis (Baily et al., 2017).
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Under Dodd-Frank, the Federal Reserve can no longer provide emergency lending to a single firm (Dugan, Fisher and Muckenfuss, 2014). Rather, the central bank can only offer broad-based lending—lending to a category of institutions, all of which must be solvent (Baily et al., 2017). In effect, this restriction forces central bankers to wait for a bank run to develop before they can lawfully act as a lender of last resort and save solvent firms from failure during credit crunches. Furthermore, the restriction intended to uproot the “too big to fail” mindset from systematically important financial institutions. While this may have been the intention, it likely has the opposite effect; the restriction likely increases moral hazards among banks. With this system in place, one company can engage in risky operations that render its competition ineligible for broad-based funding. Should the market turn and the risky firm becomes insolvent, competing banks are now disqualified to receive broad-based funding from the Federal Reserve, because not every institution in the category is solvent (Baily et al., 2017). As a final parenthetical note, the restriction on the Federal Reserve also imposes heightened disclosure requirements. Now, firms must disclose to Congress when they receive funding from the Federal Reserve. Though subject to limitations, Congress can release such disclosures to the public. Although intended to increase accountability among financial institutions to the American public, disclosure requirements could stigmatize borrowing from the Federal Reserve, thereby discouraging solvent firms from seeking liquidity until after a financial run has already taken effect (Geithner, 2017; Baily et al., 2017). Dodd-Frank also imposed restrictions on the FDIC. The law changed the rules for the Temporary Liquidity Guarantee Program (“TLGP”) operated by the federal insurer. As originally specified in the FDIC charter, the TLGP, among other things, allows the government agency to guarantee senior unsecured debt issued by
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solvent financial institutions (“Temporary Liquidity Guarantee Program”). In 2008, the FDIC implemented the TLGP for the first time in its history (Baily et al., 2017). A heralded success, the federal insurer credits the program for having “enabled financial institutions to meet their financing needs…and aided the successful return of the credit market to near normalcy” (“Temporary Liquidity Guarantee Program”). In effect, the TLGP provided timely liquidity and lowered borrowing costs for solvent financial institutions (Baily et al., 2017). Dodd-Frank restrictions add significant delays in the process to initiate the TLGP. Today, the once-independent FDIC must now seek a joint resolution from Congress to operate the emergency lending program. This restriction renders the TLGP ineffective. A swift response is critical to preventing a modest economic crisis from turning into a systemic contagion. And in this age of partisan gridlock, Congress is anything but swift in passing legislation. These two restrictions under Dodd-Frank limit the crisis management authority of the Federal Reserve and the FDIC (Dugan et al., 2014). Today, the Federal Reserve can no longer act as lender of last resort for a solvent financial institution facing a liquidity crisis. And the FDIC can no longer guarantee healthy debts without congressional approval. These restrictions impede both government agencies from quickly responding to crises. It is likely that neither entity will be able to exercise their crisis management authorities until after the vicious cycle of an extreme economic crisis has already taken effect. Simply put, these two Dodd-Frank restrictions leave America more vulnerable to extreme economic contagions. Therefore, a reform of Dodd-Frank should repeal both measures. The Federal Reserve and the FDIC need these palliative authorities to respond to a modest downturn before it becomes a systemic crisis.
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What about prevention? Stronger crisis management authorities are insufficient on their own. Just as important to responding quickly to developing crises is preventing them in first place. To this end, a Dodd-Frank reform package that repeals restrictions on Federal Reserve lending authority and FDIC debt guarantees must also include legislation that helps stabilize the U.S. economy. Such stability will help prevent extreme crises from ever occurring. The first step toward preventing extreme economic crises lies in a stronger Federal Reserve. As a final component to Dodd-Frank reform, the central bank should gain authorization to purchase broader classes of assets. Though left untouched by Dodd-Frank, dealing in assets is one of three essential monetary policy tools to provide market stability (“Federal Open Market Committee”). A reform package should include legislation expressly granting the Federal Reserve the authority to purchase broader classes of assets. The Federal Reserve provides liquidity through open-market operations. In ‘normal’ times, the central bank deals in short-term government securities to control the fed funds rate—the overnight interest rate charged on reserves lent between banks (“Open Market Operations”). Equivalent to the price of money, the fed funds rate functions as an important benchmark for the financial sector. As the 2008 financial crisis illustrated, such conventional monetary policy fails when credit is severely limited. Under these circumstances, banks can no longer afford to deposit government securities at the Federal Reserve to access liquidity. Such extraordinary times forced several rounds of unconventional monetary policies to inject liquidity into the stalled economy (Smaghi, 2009). But the Federal Reserve only wields so much power. Though subject to legal debate, Section 14 of the Federal Reserve Act (1913) specifies the classes of assets the central bank can purchase through open-market operations, namely government and
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government-sponsored securities (e.g., agency debt issue by Fannie Mae and Freddie Mac). When central bankers turned toward unconventional monetary policies during the aftermath of the Great Recession, they found their hands tied. As they began large-scale asset purchases, which some refer to as quantitative easing, policymakers could only purchase government securities and agency debt. Theory predicted, however, that large-scale purchasing of even just this class of assets would still inject sufficient liquidity into financial markets. Such predictions proved correct. The assetpurchasing programâ&#x20AC;&#x201D;which resulted in the Federal Reserve printing money to purchase nearly $4.5 trillion of agency debt on the open marketâ&#x20AC;&#x201D;injected much-needed liquidity into financial markets and helped stabilize a teetering global economy (Amadeo, 2017b; R.A., 2014; Yellen, 2016). Still, the wide-spread purchasing of government securities forced interest rates to historic lows. While a spur to economic growth, zero-bound interest rates have reduced the number of tools in the Federal Reserveâ&#x20AC;&#x2122;s toolkit. In a low interest-rate environment, there is little room for effective monetary policy (Sterland, 2017; Yellen, 2016). Thus, the central bank needs alternatives to conventional monetary policy and quantitative easing. One such alternative calls for legislation to authorize the Federal Reserve to purchase broader classes of assets, such as equities of U.S. corporations (Geithner, 2017). Central bank purchases of nongovernment assets would add stability to the U.S. economy in at least two ways. First, they efficiently inject liquidity into the economy. Financial institutions intermediate both conventional and unconventional monetary policies used in the aftermath of the great recession. There is no guarantee that banks, which deal directly with the Federal Reserve, will expand credit under expansionary policies like quantitative easing. Allowing the central bank to purchase U.S. equities and corporate debt offers a more immediate approach to injecting liquidity into the broader economy. The
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Federal Reserve could use this power to expand credit and stabilize the economy during contractionary periods. Second, broad-based asset purchases by the Federal Reserve increase the attractiveness of U.S. exports. In its own version of quantitative easing, the Bank of Japan purchased shares of exchange-traded funds (ETF) that tracked the broader Japanese economy (Fujikawa, 2014). Shortly after the program was announced the Nikkei Stock Average—an important gauge of the Japanese economy—added 30 percent. As of July 2016, the Bank of Japan had grown its holdings to about 1.9 percent of the market capitalization of equities traded on the Tokyo Stock Exchange. Over this three-year period, the Nikkei 225 and the Topix Index returned 33 percent and 8 percent respectively (Ren, 2016). As for the price of the Yen: since the $55 billion per annum ETFpurchasing program began in 2013, the Yen-dollar exchange rate has fallen by 19.4 percent as of this writing (“JPYUSD Spot Exchange Rate”). While merely correlative, the implementation of broad-based quantitative easing in Japan and the subsequent rise in Japanese securities markets can be explained, at least in part, by economic theory. Cheaper domestic currencies translate to cheaper domestic exports. This economic principle has improved the relative attractiveness of Japanese exports, aiding its own recovery with increased economic activity. As a final note, following the success of Japan’s ambitious policy, the European Central Bank began considering broad-based asset purchases itself (Randow and Black, 2014). Even Janet Yellen, Chair of the Federal Reserve, has expressed optimism about the potential stabilizing benefits of broad-based asset purchases in the United States (Yellen, 2016). The interaction between the two major benefits of broad-based asset purchases—immediate injection of liquidity into the broader economy and more attractive U.S. exports—increase demand and encourage businesses to borrow and expand current operations. The interaction would thus jolt the economy and stabilize U.S. markets, leaving them less vulnerable to extreme economic crises.
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Securing the Broader National Interest By design, Dodd-Frank affects all parties to the U.S. economy. Because of globalization, the proposed reform package will impact stakeholders far beyond U.S. bordersâ&#x20AC;&#x201D;an important intention behind the Dodd-Frank reform effort. Doing so will secure the U.S. economy from extreme crises. In turn, reforms will not only promote the national interest domestically but also internationally. But precisely whom will Dodd-Frank reforms affect? And in what ways and to what extent will these stakeholders be affected? At home, Dodd-Frank reform will directly affect public and private parties alike. On the private end, financial institutions will modestly alter their behavior. Reforms that erect a stronger public backstop would likely expand the availability of credit, because firms would be more willing to assume risk (Baily et al., 2017). Nevertheless, any credit expansion would probably be modest, as the reforms are designed to check moral hazards. On the public side, a more empowered Federal Reserve and more independent FDIC would wield additional latitude to stabilize U.S. markets and respond quickly to the next recession as it unfoldsâ&#x20AC;&#x201D; latitude they will most likely use judiciously. More power need not imply abuse of it. Before the 2008 financial crisis, the Federal Reserve and FDIC had never used their crisis management powers, which were specified in the original charters of both government entities (Bailey et al., 2017). Ignorant to this fact, Congress stripped away these authorities, fearful of independent executive agencies left unchecked with power. Should their crisis authorities be restored to levels before Dodd-Frank, the Federal Reserve and the FDIC are expected would use them only when necessary. It is expected the Federal Reserve will use broad-based asset purchases sparingly as well. As the economy expands, the Federal Reserve has begun to raise short-term interest rates and passively
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manage assets acquired through quantitative easing (Yellen, 2016). While large-scale asset purchases remain an important monetary accommodation with zero-bound interest rates, the Federal Reserve has indicated that this is but one tool in its toolkitâ&#x20AC;&#x201D;and one they do not intend to use soon (Yellen, 2016).6 The proposed reform package will positively affect other parties besides government agencies and financial institutions, albeit indirectly. Greater economic stability will benefit American households. As 2008 demonstrated, an extreme economic crisis can lead to mass unemployment, erase private wealth and leave whole neighborhoods vacant because of foreclosures. A more stable economy will also benefit American firms. The most recent economic contagion wiped away trillions of dollars in equity for publicly traded companies. And it shuttered businesses from Wall Street to Main Street. Importantly, economic policy is also foreign policy. Abroad, DoddFrank reform will predominately affect foreign governments with significant holdings in the United States, as well as foreign corporations with substantial business interests in American markets. For our allies and trading partners, a more stable economy will be a boon, facilitating Americaâ&#x20AC;&#x2122;s ability to lead in other aspects of global affairs. A robust U.S. economy will also further efforts to increase ties with Pacific-rim nations, an especially important region to American national interests moving forward. Of these east-Asian nations, the three reforms considered here will advantage one disproportionately: China, which holds more than one trillion dollars in United States Treasury bills, notes and bonds as of February 2017 (Amadeo, 2017a). American economic security will 6
On November 2, 2017, President Donald Trump nominated Jerome H. Powell as the next chair of the Federal Reserve. Despite the change in leadership, it is nevertheless widely viewed that the Federal Reserve will continue policies enacted during Janet Yellenâ&#x20AC;&#x2122;s tenure (Long, 2017).
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further intertwine U.S. interests with Chinese interests. Ideally, this will bring these nations closer. At the very least, it will reduce the likelihood of direct hostilities between the global powers. In fact, the significant Chinese holdings of U.S. securities played an important role in thwarting Russian attempts of economic assault in 2008. Further aligning Chinese and U.S. economic interests will only afford additional insurance against such attacks in the future. And this leads to the final national security consideration of DoddFrank reform: its effects on parties hostile to U.S. interests. Less prone to extreme financial shocks and better equipped to arrest the next one in its early stages, the United States would diminish the threat of economic assaults by foreign adversaries. The proposed reform package would reduce the number of opportunities of foreign attacks on U.S. markets. Once an inevitable downturn presents an opportunity, the repeals of Dodd-Frank restrictions will position the Federal Reserve and the FDIC to swiftly dispose of the threat, likely before any attack could occur. Overall, the DoddFrank reform package would substantially reduce the likelihood of a foreign assault on the U.S. economy.
Conclusion: A Strategy for Passing the Reform Package The 2008 financial crisis served as an unwelcome reminder that economic contagions are inevitable. Human nature coupled with the inherent risk of maturity transformation guarantees that markets will fail. The United States created institutions, such as the Federal Reserve and the FDIC, to mitigate threats of market failure. Institutions need developing, need to undergo trial and error. As it so happened, the government response to the aftermath of 2008 financial crisis revealed many faults within these agencies. Aware of such issues, Congress passed Dodd-Frank to reform the regulatory framework over the financial sector. Most measures in
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the law have been successful, but some went too far. And like institutions, laws are subject to trial and error, too. Accordingly, two Dodd-Frank restrictions should be repealed. First, the Federal Reserve must regain its ability to recapitalize solvent institutions during liquidity crises. The U.S. economy needs a lender of last resort to prevent the failure of a single firm from destabilizing the whole economy. Second, the FDIC must regain independence over the Temporary Liquidity Guarantee Program. Requiring congressional approval to operate the program renders it ineffective. The express purpose of the emergency authority is to allow the FDIC to swiftly prop up the value of quality assets so that firms can avoid fire sales. The requirement of congressional approval imposes capricious delays in operating this vital crisismanagement tool. In addition to repealing these two Dodd-Frank restrictions, a third measure should be included in the reform package. The Federal Reserve should gain the authority to purchase broader classes of assets on the open market. This would equip the Federal Reserve with another tool to ensure economic stability, especially important today when policymakers have little room to use monetary and fiscal policy. Together, the reform package will reduce Americaâ&#x20AC;&#x2122;s vulnerability to an extreme economic crisis. It will also empower the government to respond to a moderate downturn swiftly and appropriately, preventing it from becoming a full-blown contagion. In short, the reform package will foster economic security. To ensure its effectiveness, this reform package must pass through Congress before the next contagion begins. To this end, it is recommended that advocacy efforts behind the reform implement a focused strategy to press for these changes. Reform advocates should first persuade generals and other leaders of the U.S. armed forces community. Advocates should then convince U.S. diplomats
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of the merits of the reforms as well. With support from the Department of Defense and the State Department, it is recommended that reform advocates then direct these leaders from across the foreign policy community to press members of Congress to codify the reform package into law. Having applied grass-tops pressure, advocates should next target members of the House Committee on Foreign Affairs, as well as their colleagues serving in the House Committee on Financial Services. Likewise, they should assume a similar dual-committee approach in the Senate, simultaneously lobbying members of the Senate Foreign Relations Committee and the Senate Banking Committee. Finally, foreign policy leaders should use the media to garner backing from the public. Grassroots support will apply additional pressure on Congress to pass these reforms. A sequential, coordinated, grasstops and grassroots lobbying effort offers a promising strategy to pass the Dodd-Frank reform package proposed in this essay. As former Defense Secretary Panetta (2012) shared with Congress, if our economy suffers, we will fail â&#x20AC;&#x153;to maintain the leadership position we have in the world.â&#x20AC;? To motivate Congress to act, we need to make this connection, to make this argument: Dodd-Frank needs reform, not for the sake of Wall Street, not for corporate interests, indeed not for any reason other than for the national interest. Economic security is national security.
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Amadeo, K. (2017a, April 17). U.S. debt to China: How much does it own? The Balance. Retrieved from https://www.thebalance.com/u-s-debt-to-china-how-muchdoes-it-own-3306355 Amadeo, K. (2017b, April 17). What is quantitative easing? Definition and explanation. The Balance. Retrieved from https://www.thebalance.com/what-is-quantitative-easingdefinition-and-explanation-3305881 Baily, M. N., Klein, A., & Schardin, J. (2017). The impact of the Dodd-Frank Act on financial stability and economic growth. RSF: The Russel Safe Foundation Journal of the Social Sciences, 3(1), 20â&#x20AC;&#x201C;47. Bullard, J. (n.d.). The Financial Crisis: Full Timeline. Federal Reserve Bank of St. Louis. Retrieved from https://www.stlouisfed.org/financial-crisis/full-timeline Dugan, J. C., Fisher, P. R., & Cantwell F. Muckenfuss III. (2014, September 4). Responding to Systemic Risk: Restoring the Balance (Financial Regulatory Reform Initiative). Washington, D.C.: Bipartisan Policy Center. Federal Open Market Committee. (2017, April 6). Board of Governors of the Federal Reserve System. Retrieved from https://www.federalreserve.gov/monetarypolicy/fomc.htm Federal Reserve Act, 12 USC 353 § Section 14. Open-Market Operations (1913). Retrieved from https://www.federalreserve.gov/aboutthefed/section14.htm Fujikawa, M. (2014, August 12). BOJ steps up ETF purchases as shares slump. The Wall Street Journal. New York, NY.
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Retrieved from https://www.wsj.com/articles/boj-steps-upetf-purchases-as-shares-slump-1407830786 Geithner, T. L. (2017, February). Are we safe yet? How to manage financial crises. Foreign Affairs, 96(1), 54–72. GDP ranking, PPP based. (2017, April 17). The World Bank. Retrieved from http://data.worldbank.org/data-catalog/GDPPPP-based-table JPYUSD spot exchange rate. (2017, April 21). Bloomberg Markets. Retrieved from https://www.bloomberg.com/quote/JPYUSD:CUR Lew, J. L. (2016, June). America and the global economy: The case for U.S. leadership. Foreign Affairs, 95(3), 56–68. Long, H. (2017, November 2). Who is Jerome Powell, Trump’s pick for the nation’s most powerful economic position? Washington Post. Washington, D.C. Retrieved from https://www.washingtonpost.com/news/wonk/wp/2017/10/3 1/jerome-powell-trumps-pick-to-lead-fed-would-be-therichest-chair-since-the-1940s/ Nanto, D. K. (2011). Economics and National Security: Issues and Implications for U.S. Policy (CRS Report for Congress No. 7–5700). Washington, D.C.: Congressional Research Service. Nonbank Financial Institutions—Overview. (n.d.). Federal Financial Institutions Examination Council. Retrieved from https://www.ffiec.gov/bsa_aml_infobase/pages_manual/olm _091.htm
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Open Market Operations. (2007, August). Federal Reserve Bank of New York. Retrieved from https://www.newyorkfed.org/aboutthefed/fedpoint/fed32.ht ml Panetta, L. E. Defense Budget Request, § House Budget Committee (2012). Washington, D.C. Peston, R. (2014, March 17). Russia “planned Wall Street bear raid.” BBC News. Retrieved from http://www.bbc.com/news/business-26609548 R.A. (2010, March 15). Does the zero bound bind? The Economist. Retrieved from http://www.economist.com/blogs/freeexchange/2010/03/mo netary_policy Randow, J., & Black, J. (2014, December 4). ECB said to prepare broad-based QE plan for January meeting. Bloomberg Markets. Retrieved from https://www.bloomberg.com/news/articles/2014-12-04/ecbsaid-to-prepare-broad-based-qe-package-for-januarymeeting Ren, S. (2016, August 27). How the Bank of Japan Favors the Nikkei 225. Barrons. Retrieved from http://www.barrons.com/articles/how-the-bank-of-japanfavors-the-nikkei-225-1472271673 Rothkopf, D. J. (2014). National Insecurity: American Leadership in an Age of Fear. New York, NY: Public Affairs. Smaghi, L. B. (2009, April 28). Conventional and unconventional monetary policy. European Central Bank. Retrieved from https://www.ecb.europa.eu/press/key/date/2009/html/sp0904 28.en.html
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Sterland, B. (2017, February 14). Part I: Global finance resilience in a time of uncertainty. Retrieved from https://www.brookings.edu/blog/up-front/2017/02/14/globalfinancial-resilience-in-a-time-of-uncertainty/ Swagel, P. (2010). The cost of the financial crisis: The impact of the September 2008 financial collapse. Presented at the Financial Reform: Too Important to Fail, Pew Financial Reform Project. Temporary Liquidity Guarantee Program. (2013, February 27). Federal Deposit Insurance Corporation. Retrieved from https://www.fdic.gov/regulations/resources/tlgp/index.html The slumps that shaped modern finance. (n.d.). The Economist. Retrieved from http://www.economist.com/news/essays/21600451-financenot-merely-prone-crises-it-shaped-them-five-historicalcrises-show-how-aspects-today-s-fina Willige, A. (2016, December 5). The worldâ&#x20AC;&#x2122;s top economy: The US vs China in five charts. World Economic Forum. Retrieved from https://www.weforum.org/agenda/2016/12/the-worlds-top-economy-the-us-vs-china-in-five-charts/ World Economic League Table 2016 Highlights. (2015). London: Centre for Economics and Business Research. Yellen, J. L. (2016, August 26). The Federal Reserveâ&#x20AC;&#x2122;s monetary policy toolkit: Past, present, and future. Board of Governors of the Federal Reserve System. Retrieved from https://www.federalreserve.gov/newsevents/speech/yellen20 160826a.htm
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Lives and Livelihoods: The Economic Impact of Ebola in West Africa By Joniel Cha
The Ebola epidemic ravaged West Africa in 2014, not only causing a public health crisis, but also damaging the economy. During the outbreak, the international community responded too late and initially provided insufficient funding. At its core, however, the Ebola virus took the heaviest toll on the work force, severely damaging the labor market and national productivity. The World Bank issued an emergency response commitment of up to $500 million, the International Monetary Fund (IMF) pledged $130 million in crisis funding, and the G-20 announced $300 million to combat Ebola (CSIS, 2014). The United States, European Union, and United Kingdom also made monetary commitments, and the United States Agency for International Development (USAID) and the Centers for Disease Control and Prevention (CDC) were on the ground. The World Health Organization (WHO) estimated there were more than 3,500 Ebola cases with over 1,900 deaths in September 2014 (Morrison, 2014). After originally proposing a $100 million commitment in July 2014, the WHO drastically increased its commitment to $600 million the following month (Morrison, 2014). This underscored the dire need for emergency stabilization and recovery – and the multilateral organizations’ miscalculations. While the West African economies showed growth in 2014, they were still fragile. Most of the economic impacts came not from sicknesses, but from people practicing “aversion behavior” to avoid Ebola exposure (CSIS, 2014). Fear of the disease, distrust of government, and cultural norms against quarantine explained some of this behavior. Travel and tourism plummeted significantly in West Africa during
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the summer of 2014 (CSIS, 2014). Trade also declined, as reflected by the fall of the wage and self-employed sectors. The vast majority of people were not working due to the direct effects of Ebola, as employees became sick, companies closed down, and employees were unable to travel or transport goods. These employment effects were spread across West Africa irrespective of Ebola case rates in certain cities or areas. Due to Ebola, the GDP fell two to four percent in Guinea, Sierra Leone, and Liberia (CSIS, 2014). Because the poverty rate was 50-60 percent, the poor became even poorer (CSIS, 2014). Children went without food, and parents were unable to provide for them. To make matters worse, schools were closed, further hurting human capital investments. As governments shifted their budgets toward emergency funding for Ebola, development projects took the brunt of the damage. Funding set aside for road maintenance, education, and other social services and programs was redirected towards the Ebola response. The IMF revised its 2015 economic outlook for West Africa in light of Ebola, predicting the GDP loss in West Africa to be $2.2 billion (CSIS, 2014). The Ebola epidemic devastated West Africa. Over 28,600 people were infected and 11,300 died (Blaszczak-Boxe, 2016). The World Bank spent $1.6 billion for the Ebola response (UN Development Group, 2015). Officials declared the epidemic contained during the winter of 2015, but aversion behavior was not (Rettner, 2016). At the community level, quarantines were not adhered to, and burials were unsafe, increasing the risks of transmission, illness, and death (Morrison, 2014). Liberia and Sierra Leone experienced civil war during this time, exacerbating the spread of Ebola through refugees and adding shocks to the economy (UN Development Group, 2015). Expertsâ&#x20AC;&#x2122; prognostications regarding West Africaâ&#x20AC;&#x2122;s economic damage due to the Ebola epidemic were prescient. Higher unemployment, lost incomes, interrupted schooling, and food
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insecurity adversely affected the economies of West African countries. Commodity price shocks (falling prices of bauxite, iron ore, and gold) induced by the Ebola epidemic led to the combined loss of $2.8 billion (compared to Evansâ&#x20AC;&#x2122; prediction of $2.2 billion) in West Africa: $600 million in Guinea, $300 million in Liberia, and $1.9 billion in Sierra Leone (Zafar, Talati, & Graham, 2016). Real GDP growth declined markedly in 2015 in the three most affected countries: 0.3 percent for Liberia, 0.1 percent for Guinea, and -21.5 percent for Sierra Leone (Zafar et al., 2016). However, inflation was contained. There are many lessons to be drawn from the Ebola epidemic in West Africa. At the outset, governments must take steps to contain an epidemic, restore confidence, and reduce aversion behavior. By doing so, the countries will effectively mitigate the epidemicâ&#x20AC;&#x2122;s effects on their economies. Due to dwindling finances, each government must provide fiscal support in a timely manner. Although there was a fantastic response from the international community with resources to counter the spread of Ebola, it was a delayed response. In addition, budget support for these governments was very small, given losses, bankruptcies, and closures in the private sector. In the long run, poverty outcomes were accentuated without the virusâ&#x20AC;&#x2122; eradication. To make up for the economic losses, governments should encourage trade with careful surveillance. There were differentiated impacts in each of the three West African countries; for example, mining activity continued in some areas. Additionally, governments should endeavor to restore investor confidence. The Ebola outbreak was a temporary shock and not a catastrophic impact, such as one as caused by war. Because West African households planted and harvested food themselves, there were relatively few immediate food security concerns at the micro level. As outlined above, the international community would be wise to note the economic lessons from the Ebola epidemic in preparation for a future disease outbreak. The heaviest toll from Ebola was on
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the most active segment of the population (15-44 years of age): the labor force (UN Development Group, 2015). This negatively affected the labor market and national productivity. Over 16,600 children lost one or both of their parents to Ebola, making them more vulnerable to poverty. Emergency preparedness, public health education, and virus-detection monitoring and surveillance mechanisms and programs must be enhanced and established. Otherwise, as experts can attest, the economic results from a future virus epidemic will be devastating (Tables 5 and 6).
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Blaszczak-Boxe, A. (2016). Ebola May Leave Survivors with Lasting Problems in Brain, Nerves. LiveScience. Retrieved from http://www.livescience.com/53836-ebola-survivors-healthproblems.html Center for Strategic and International Studies (CSIS). (2014). Economic Impact of Ebola. CSIS. Retrieved from https://www.csis.org/events/economic-impact-ebola Evans, D. K. (2014). The Economic Impact of the Ebola Epidemic: Short & Medium Term Estimates for West Africa. World Bank. Retrieved from http://www.worldbank.org/en/region/afr/publication/theeconomic-impact-of-the-2014-ebola-epidemic-short-andmedium-term-estimates-for-west-africa Morrison, S. (2014).Ebolaâ&#x20AC;&#x2122;s Hard Lessons. CSIS. Retrieved from https://www.csis.org/blogs/smart-global-health/ebolas-hardlessons Rettner, R. (2016). Guinea No Longer Free of Ebola: 2 New Cases. LiveScience. Retrieved from http://www.livescience.com/54098-guineanew-ebola-cases.html United Nations Development Group â&#x20AC;&#x201C; Western and Central Africa. (2015). SocioEconomic Impact of Ebola Virus Disease in West African Countries. United Nations. Retrieved from https://reliefweb.int/sites/reliefweb.int/files/resources/ebolawest-africa.pdf
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World Health Organization (WHO). (2016a) â&#x20AC;&#x153;New Positive Case of Ebola Virus Disease Confirmed in Liberia.â&#x20AC;? 1 Apr 2016. http://www.who.int/mediacentre/news/statements/2016/liber ia-ebola/en/ World Health Organization (WHO). (2016b). West Africa Ebola Outbreak: Funding. WHO. Retrieved from http://www.who.int/csr/disease/ebola/fundingrequirements/en/ Zafar, A., Talati, C., & Graham, E. (2016). 2014-2015 West Africa Ebola Crisis: Impact Update. The World Bank. Retrieved from http://www.worldbank.org/en/topic/macroeconomics/public ation/2014-2015-west-africa-ebola-crisis-impact-update