I am rarely surprised when those who are not economists make egregious economic errors. I am only moderately surprised when those errors are in the Financial Times. I suppose I should get used to it.
Here’s a little basic economics. Economists, whether talking about banking or housing, trees or oil, always follow a set of fundamental principals. These include very basic ideas. For example, when conducting cost-benefit analysis, count the entire range of relevant benefits and costs. Say you want to do an economic analysis of a project to build a bridge. You count all the costs—labor, materials, etc.—and all of the benefits—shorter driving/commuting times, decreased congestion, etc. You don’t leave any out. Intuitive, right? Well, no, because a lot of people get it wrong.
The latest example of this sort of error was in the FT today.
If you read my posts, you might be aware that when it comes to bribery and corruption I am often skeptical and even more frequently condemnatory. But I also try to give credit where it’s due. Despite my criticisms and my often snarky tone, my message is one of guarded optimism. I am optimistic in the face of the shortcomings and the outright failings of our international systems because I see a positive trajectory. More trials of foreign bribery, more exposures of government corruption, and [even] more revelations of dictator’s deposits in foreign banks are all good signs. Of course they are not good things, but rather they show that the international community is seriously talking about these issues, not leaving them hidden and tacitly accepted. These problems are far from solved—and I would love to see fewer reports of all of these evils—but they are signs that we are moving forward.
Today I am confronted with a new sign; however, one which I hope is not part of a larger trend. First a little background.
For many years economists and policy makers have taken issue with GDP as a measure of national wealth. Statistics like these tend to over-emphasize certain elements of wealth and under-estimate others. Economists often point to the fact that, for example, income generated from the sales of cigarettes is included in GDP (something which might actually have negative value) while value generated from a stay-at-home-mom (or dad) is not. As I’ve noted, there are problems with other economic indicators like the Consumer Price Index (CPI), the unemployment rate, and the traditional measure of Illicit Financial Flows—all of which are used to measure economic progress and form an integral basis of public policy decisions. But the problems with GDP are often more widely discussed and emphasized than with these others because it is such a universal and ubiquitous benchmark of national well-being.
To solve this problem, economists have tried other measures of well being—for example the Human Development Index (HDI), which the United Nations uses to measure development. The HDI assesses countries on three dimensions—income (measured in GDP), health (measured in life expectancy at birth) and education (measured in mean years of school and expected years of schooling). The HDI has gone far to push our traditional understanding of wealth and development and certainly gives a more comprehensive view of these issues. But the HDI does not solve many of the short comings of GDP. It does not include, for example, environmental goods—like clean air and water, which certainly have economic value—or governance values of human rights or freedom from corruption.
On October 12th, 2002, a group of terrorists detonated three bombs on the island of Bali in Indonesia, killing 202 and injuring 240 more. The two larger bombs targeted foreign tourists in a nightclub area and the smaller bomb detonated outside the United States consulate and caused minor damage. In 2008, Indonesia executed three of the more than 30 people convicted in connected with the mass murders. Many of these convicts were associated with Jemaah Islamiyah (JI), a militant Islamist group in Southeast Asia. The United States believes JI has ties to al-Qaeda and (had) a relationship with Osama Bin Laden.
But authorities had postponed these executions numerous times after sentencing, nervous about the political and security ramifications. Many, including the inmates themselves, believed their deaths could become a rallying point for supporters. Indeed, after their deaths, thousands of supporters welcomed their bodies by rallying and chanting “God is Great.”
Until the deadly attacks in 2002, Indonesia had largely resisted international pressure to crack down on suspected terrorists and denied the terrorist organization al-Qaeda had an internal presence or connections to domestic groups. In response to this event, however, Indonesia’s stance evolved significantly. Indonesia’s defense minister made a statement that he was “sure that al-Qaeda is here” and the country significantly increased cooperation on counterterrorism with the United States.
If companies were people and those who violated the laws were criminals, then BAE Systems would be a repeat offender. Actually I’m not sure repeat offender even begins to cover it. Here’s some background.
BAE Systems is a defense contractor with products and services for air, land, and naval forces, including electronics, intelligence, weapons, among many others. It’s a British company, but over half of its $12 billion annual sales in its land and armaments business is with the United States. According to the Stockholm International Peace Research Institute, BAE is the largest armaments company in the world.
But BAE’s accomplishments seem all the more…noteworthy…given its colorful history.
In 2008 the Financial Times uncovered BAE paid £20 million to John Brendencamp, who was involved in supplying arms to the Zimbabwean army. BAE made these alleged payments through a subsidiary in the British Virgin Islands, a secrecy jurisdiction. The evidence strongly suggested these payments were in direct violation of the arms sanctions against Zimbabwe. At the time, BAE was under investigation in several other countries for bribery.
Over the last decade or so, investment banks have chronically put their profits ahead of the interests of the community. Take Goldman Sachs, the investment bank, that sold complex financial structures en masse, which helped spread toxic mortgages throughout the financial system. In 2008 our financial system nearly collapsed, in large part because of these toxic mortgages. Goldman Sachs actually profited from that meltdown, by putting millions of dollars into a subprime mortgage deal in 2007. Soon after that little stunt, the firm paid a settlement fine of $550 million to the Securities and Exchange Commission (SEC) for charges of fraud and misleading investors. Robert Khuzami, head of the SEC, glowingly called it a “heavy price.”
The next day, Goldman Sachs’ share price rose $7…obviously the market didn’t agree.
Goldman’s total rise in share price added more than $1 billion to its market value. In the wake of this debacle, many analysts argued “the stock market…believes that Goldman has struck an amazing deal with the SEC.” Pro Publica, a non-profit investigative reporters group, calculated that the fine was worth less then one-tenth of the gain Goldman’s stock enjoyed after word of the settlement and it was only slightly less than the amount the company donated to help small businesses after criticism of its bonus structure. Arlen Specter, then Democratic Senator from Pennsylvania, gave a speech on the Senate floor questioning whether this behavior crossed “the criminal line.” Arguing that major companies consider such fines “a cost of doing business,” Specter contended: “I have long been concerned about the acceptance of fines instead of jail sentences in egregious cases.”
In the wake of Egypt’s revolution that forced President Hosni Mubarak to step down on February 11th, the country’s interim government has been making a lot of changes, including taking action against the former administration. The government imprisoned a host of powerful former statesmen under Mubarak including Gamal and Alaa Mubarak, sons of the former president, all of whom authorities detained for 15 days and questioned about corruption and abuse. Also imprisoned were Ahmed Nazif, the former prime minister; Zakaria Azmi, the president’s right-hand man; and Fathi Sorour, the former speaker of Parliament. In April, Egypt’s Supreme Court ruled the National Democratic Party, Mubarak’s once dominating political party, would be dissolved and its assets seized by the government. Now, last week, an Egyptian court sentenced the former interior minister, Habib el-Adly, to 12 years in prison and fined him about $4 million for profiting illegally from his office and money laundering.
But el-Adly’s crimes don’t stop there. In April a state-appointed fact-finding mission found el-Adly—and Mubarak—responsible for the deaths of 850 protestors killed in violence in anti-government unrest because el-Adly, as the president’s interior minister, ordered security forces to use live ammunition on protestors. Other human rights groups have accused el-Adly of routine police brutality over his decade of service as Mubarak’s security chief.
Since his election Russian President Dmitry Medvedev has been talking about corruption. The subject has had prominence in many of his speeches since his campaign in 2008. In September of 2009 he announced a major reform program aiming to tackle rampant corruption in his country, although he didn’t actually detail what the reform program would include. Medvedev has also repeatedly vowed to tackle corruption in the court systems, stating that Russia should do its best to “make the courts become as much as possible independent from the authorities and at the same time to absolutely depend on society.” For all this vowing and announcing, you’d think we’d have actually seen some progress in this area. We haven’t.
Maybe we should be surprised. Well, not if you listen to Medvedev. As he said in 2011 (and 2010) he has “no illusions that this will happen in one or two years, but I’m happy that we’ve begun this job.” Just a year earlier Medvedev admitted he knew “of no significant successes in this direction,” despite two years of effort.
But all of this talk is pretty suspect anyway. As internal State Department memos–which were made public by WikiLeaks–reveal, the top levels of Russia’s government are engaged in a much deeper and more pervasive type of corruption than most of the world has realized. One cable notes that extortion is so widespread that it has “become the business of the Interior Ministry and the federal intelligence service.” The government has transformed into an organization more closely resembling “the mafia” and the line separating government from business is so blurred it is nearly non-existent.
Behind only fear and tragedy, Osama bin Laden’s most enduring legacy on our world will be the changes in national and international security. Our response to his hate—and the attacks he orchestrated on September 11th—was overwhelming shaped by our collective realization that many of our security systems cannot protect against those who want so badly to do us harm. The most conspicuous of these systematic changes was—of course—in air transportation, as anyone who has flown before and after 2001 can tell you. The United States’ capacity to respond to terrorist attacks was also improved with the creation of the Department of Homeland Security, which marked the largest restructuring of the federal government in contemporary history. Congress also passed the USA Patriot Act to detect and prosecute terrorists, which remains most famous for its reduction in the restrictions on law enforcement agencies’ ability to search telephone communications and other records.
Of course there have been many other changes—both large and small—for better or for worse. But the U.S. did have one other important response to September 11th that is worth noting on this blog, particularly in light of recent events. And that is the prioritization of and improvements in anti-money laundering legislation and the detection of terrorist financing.
In 1998, an article in the Washington Post argued bin Laden was able to “shroud his finances in such secrecy and with so many front companies that American officials acknowledge it could take years to decipher them.” At the time, U.S. officials understood that the key to bin Laden’s power was wealth—which was extensive as he inherited a substantial sum of money from his prosperous Saudi father. Yet they were often stymied in their ability to track his or other terrorists’ resources as they did not have the capability to comprehensively track, freeze, and seize assets.
I live in Oregon where there is no sales tax. Before I moved here, I took the sales tax for granted. If a bottle of coke costs $1.00 then you can expect to dole out a dollar bill and some change. Now, I go to a restaurant and my bill always comes in a rounded figure. Imagine that!
But I digress. The lack of a sales tax gives Oregon something of an advantage of its neighbors to the North and South. Many who live in Vancouver, Washington, for example, will venture across the border to buy expensive items in Portland—creating jobs and incomes in Oregon. Those who live in Seattle, however, are less likely to make the long trip. So until recently most states—particularly those in the West where borders are few and far between—didn’t have much of a problem.
That has changed with the rapid rise of e-commerce. According to a study at the University of Tennessee, yearly e-commerce sales rocketed from $995 billion in 1999 to an estimated $4 trillion in 2011. State tax codes were not written to deal with this magnitude of inter-state transactions, so needless to say there’s been some friction in the last decade. I won’t bore you with the entire history. Here’s the short version. By law, most websites are not required to collect sales tax on purchases by out-of-state customers. This gives retailers like Amazon and Overstock a pretty nice advantage the general store down the street.
Ever since the general introduction of the body scanner and enhanced pat-down in airport security lines, there’s been a furious debate in America over just how much privacy we are willing to give up for the sake of our safety in the skies. Organizations like the American Civil Liberties Union (ACLU) argue that security should not “come at the expense of civil liberties.” Other people just don’t feel comfortable with strangers seeing them virtually naked. Those on the other side argue the loss of privacy is an unfortunate byproduct for the reassurance of safety.
In the last few weeks the Federal Aviation Administration (FAA) has come under fire after it was discovered that in several states and Washington, DC air traffic controllers have fallen asleep while working overnight shifts. In response, the FAA launched an official review and Henry Krakowski, who oversaw the air traffic control system, resigned in embarrassment.
These anecdotes are emblematic of the enormous value that the United States—and indeed most of the world—has placed on security in the air. When we hurtle through the air at 565 miles per hour in a 200 ton, six-story tall, aluminum flying-machine with 63,500 gallons of highly combustible jet fuel sitting below us, many of us feel apprehensive. And we want some reassurance that we are safe—from both accident and malice. As a result we debate just how much we are willing to give up for security and we quickly and harshly condemn those whose mistakes put our safety at risk.
For years economists have talked about the “end of the euro.” These apocalyptic warnings have become only more severe in recent years and months, with the weakening of Europe’s economic and financial position and the debt crises in Portugal, Spain, Greece, and Ireland, which have triggered discussions of these countries unilaterally dropping the euro. In truth, however, economists have talked about the end of the euro since the beginning of the euro, when even after it was formally adopted as the third pillar of the European Union in the Maastricht Treaty of 1992 many economists have remained deeply skeptical.
There are obvious advantages for the collective whole. The euro improves the flow of intra-European trade, minimizes exchange rate volatility, and saves travelers and businessmen on costly currency exchanges. There are benefits for individual countries, as well. Some European countries which traditionally had high levels of public debt have benefited from low inflation and interest rates. Other countries with traditionally strong currencies hope the Euro possess a slightly weaker, and therefore more favorable to trade, exchange rate.
Among the dozens of arguments about the weaknesses of the euro presented by cynical economists, there is one major disadvantage to the euro, which while not sufficiently strong enough to motivate dissolution, but should be critically important to how we think about a common currency’s advantages and disadvantages. And that is the euro’s appeal to money launderers.