Category Archive: Analysis

  1. Red Finance

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    In terms of its size, dynamism, and degree of global integration, China’s market economy is extraordinary. Though it’s known officially as a “socialist market with Chinese characteristics,” its market features far predate the 1978 decision on “reform and opening.” The reformist Chinese growth model has always been characterized by a distinct pragmatism. This involves integrating macro programming and regulations, a mix of public and private ownership and control, market allocation to various degrees of resources and distribution, bureaucratic cronyism in productive and business organizations, and international “free trade.”

    This model is the outcome of decades of adaptation and innovation. While much has been written on pre-nineteenth century Chinese economic strategy, far less attention has been paid to the wartime fiscal and monetary experiments undertaken during the Communist Revolution. In an effort to rectify this oversight, I review revolutionary economic policy from the 1920s until the 1940s, reflecting on its theoretical and institutional implications. 

    The pacified empire

    The unified Qin–Han state originated from an amalgam of the annals of Warring States around the same time as the rise of Rome in the Western Hemisphere. While the Roman Empire fell in the fifth century, imperial China outlived it and subsequent empires. This longevity was in part rooted in its socioeconomic arrangements. Trade had flourished early with extensive internal and external networks across continental and maritime expanses, encompassing numerous silk roads and transportation routes to reach many societies and cultures. 

    Prior to 1800, the Chinese, Indian,  East Asian, Southeast Asian, and Arab economies were weightier producers than their counterparts elsewhere.1 In The Wealth of Nations, Adam Smith recognized that “China is a much richer country than any part of Europe,” despite signs of stagnation.2 Instead of an industrial revolution, the Chinese accomplished an “industrious revolution,” argued Giovanni Arrighi, consistent with a Smithian path of “natural progress of opulence” rather than the “unnatural and retrograde” European path of interstate rivalries over power and colonial extraction.3 China at its splendor was so wealthy, thanks to regions like the Yangzi Delta, that while Europe was compelled to adopt machines to cut labor costs, “China didn’t ‘miss’ the industrial revolution—it didn’t need it.”4

    By the fifteenth and sixteenth centuries, China had become the largest trader on the silver standard, contributing to the emergence of global capitalism but without transforming into a colonial empire. In a review of Chen Huan-chang’s 1911 The Economic Principles of Confucius and his School, John Maynard Keynes noted China’s trimetallic system dating back to “the remotest times,” observing that in the use of paper money, the Chinese “long anticipated other peoples.”5

    Accordingly, “cooperative banks” were invented around 220 AD, and, in subsequent centuries, developed into government and shadow banking of coins, notes, bills, bonds, and “flying money”—money certificates to “control the price of all commodities.”6 In place of the liberal legal institutions, credit systems, and public budgeting that characterized early modern Europe, the Chinese economy operated through informal arrangements of properties and contracts, claims and debts, rights and liabilities, which relied on personal and family ties, townsmen associations, and other private partnerships.7 Ingenious transactions and lending in China’s commercial centers notwithstanding, underdeveloped financial infrastructure and stimuli of the economy came to be a competitive disadvantage. The “pacified empire,” Max Weber remarked, was a contrast to war-financed “varieties of booty capitalism” in Europe, where states enriched themselves “through war loans and commissions for war purposes.”8

    Economic difficulties and political turmoil around the transition from Ming to Qing were an instance of the financial weakness of the Chinese imperial monetary system. Under Europe’s financial hegemony, major inflation in China was directly caused by the depletion of silver inflow in the seventeenth-century world crisis.9 En route, European ocean vessels linked American cotton and mining products derived from slave labor and trade from Africa with the Chinese-Indian-Arab markets. Gunder Frank recounts this gigantic trading triangle in which the Europeans took out American silver to “buy themselves tickets on the Asian train.”10 Finding itself a “bottomless pit” for the influx of American silver and its monetization, China became dependent on foreign currency supplies and offshore exchange rates. This was not only economically but also politically costly, as the monetary arbitrage from the externally forged silver standard undermined the Chinese state. Foreign banks and other financial institutions had also come to China since the late-nineteenth century, hence the formation of a Chinese comprador class of financiers and financial brokers who locally facilitated imperialist super profits and rents.

    Lacking the capitalist mechanisms of creative destruction and limitless accumulation, the premodern Chinese economy followed its own patterns of evolution—or involution, as some economic historians prefer to characterize it. Examples of its working methods are many: state depots of an “ever normal granary” (changpingcang) to balance seasonally fluctuated grain prices and regional price differentials; periodic government procurement of other essential goods in preparation for disaster relief and the easing of lean time market pressure; and recurrent reforms to unify taxation, regulate commerce, and calibrate competition. These ideas and institutions, refined over successive dynastic regimes, have been studied by economists, historians and sociologists in a growing scholarship of comparative economic history. 

    Among the most well known classics is the Guanzi (seventh century BC). Two millennia before the advent of classical and neoclassical economics, this economic-philosophical text, believed to be a reflective record of the economic principles discussed between the Duke of Qi and his prime minister Guan Zhong in the Chun-Qiu period, can be read contemporarily. The core argument is a “heavy-light” distinction in the hierarchy of importance attached to goods in their production and trade, which determines the need for, and techniques of, official pricing. To ensure adequate supply of the “heaviest” items, for example, the government must “stabilize the price of grain in order to stabilize the overall price level and the value of money.”11 On Salt and Iron is another famous classic, a collection of documents on the salt and iron debate between the realist Guanzians and the moralistic Confucian literati. At a West Han conference (81 BC), the former group as policy advocates promoted state intervention as an obligation for economic prosperity and price stability. The latter group, on behalf of aggrieved producers and merchants suffering predatory officials, lamented a foregone age of pliable governments.12

    Following the Wu emperor (141-87 BC) who endorsed rounds of monetary reform, central monopolies of salt and iron developed, and became a staying policy. The state reined in fierce competition among the large landed and mercenary interests. These events were analytically narrated in such writings as “treatise on foodstuffs” and “usurers.”13 Ban had incorporated what was earlier documented in the “biographies of usurers” (book 129) and “a treatise of leveling” (pingzhun shu, book 30) by Si Maqian in the Records of the Grand Historian. The pingzhun officials were assigned to the balancing act of market stabilization by organizing “selling [crops etc.] where and when they are scarce and dear, and buying them where and when they are bountiful and cheap.” This particular conception and measure of pingzhun, together with the heavy-light differentiation based priorities, are perhaps the most outstanding of the ancient economic wisdoms in laying the policy foundation of China’s future economic performance.14

    Power and adaption

    In contrast to China’s pre-communist economic history and thought, wartime communist economic management has been largely neglected outside of China. The fusion of old wisdoms and novelties in this unique experience, however, deserves greater attention. 

    The story begins with the first tide of the labor movement in the early 1920s. The Chinese Communist Party (CCP) and its Trade Union Secretariat resolved to amalgamate political and economic class struggles. Its earliest experiment with shareholding cooperation was a self-managed cooperative for the coalminers and railway workers in Anyuan, Hunan, in 1923. This effort initiated the use of membership “red shares” and coupons. Mao Zemin, a younger brother of Mao Zedong’s, was twice its general manager. After the Guomindang (GMD) right wing slaughtered tens of thousands of communists and sympathizers in 1927, the CCP retreated from urban agitation and recruited at the rural margins. In these areas, cooperative farms, workshops, credit, trading and remittance networks developed widely, with voluntary participants as shareholders of specialized or multifunctioning cooperatives.15

    The cooperatives were also a vehicle of mutual aid and political education. Yu Shude, a party veteran since 1922, recognized that “creating collective power through cooperation” was a means for the vulnerable majority of the Chinese population to forge political ties. The ultimate aim was to replace private property, but “before the new social organization can be established, cooperation is the rescue for petty producers.”16 This idea was popular, and it echoed in the non-communist reform movements for Rural Reconstruction and Popular Education.17 It later accented the national rural cooperative campaign of the 1950s and was revived through the “Marxist theory of cooperation” to legitimize collectivization in the early 1980s.    

    The uneven nature of Chinese development and the temporal-spatial specificities of the Chinese revolution bore significant implications for the revolution’s economic orientation. State building in the People’s Republic thus began in the rural peripheries decades before the CCP came to national power, with the strategy of “encircling the cities from the countryside.” The revolutionary bases were created and expanded in discrete territories to break the weak links of counterrevolution. This was possible because imperialist powers and their local pillars in China were divided, and conflicts among the warlords were pervasive. In his analysis of how the small, separatist red regimes could survive privation and isolation, Mao highlighted semi-coloniality and the indirect nature of imperialist rule. 

    In the absence of an integrated national market, the red forces could carve out their own territories around the borders of several provinces away from the counterrevolutionary strongholds. However slim, the opportunity gave rise to the daring endeavor to build the “armed independent power of workers and peasants” as a “movable counter power.” Ultimately, the revolutionaries sought to aggregate a historical bloc out of this “state within the state.”18 During the next waves of revolution, they were vindicated, as a single spark did start a prairie fire.

    Mao was writing in the mountainous provincial edges where the first Chinese red army regiments battled to win a primitive home as the cradle of an armed revolution. The Jinggang base was the first among communist local regimes to survive attacks by extreme adversaries. For the base, economic viability meant life or death. 

    Central to the party’s minimum program was land revolution. This revolution was of epochal significance in overturning China’s thousands of years old “feudal” (a borrowed term in the communist vocabulary) order, which entailed the polarity of land concentration and landlessness, the collusion of landlords and bureaucrats, widespread miseries and stalled modernization. The communists sought to alter the division between capital accumulation and productive investment which resulted from land purchases and usury. By the same token, as the landed, money-owning, and power-holding classes were jointly destroying the agricultural base of Chinese society, the country’s legendary but stifled productive forces were invigorated thanks to the redistribution of land.

    In the following two decades, the CCP carried out this effort while remaining sensitive to changing political circumstances. Policies on land redistribution or rent reduction engaged the regional communist governments, the red army, the trade unions, peasant associations, women’s federations, and other mass organizations. Without the economic conventions directed by a landed and patriarchal gentry, the party prioritized productive self-sufficiency, popular livelihood and military provision.

    Trade was a predominant priority for impoverished red regions. Tungsten mining in the Jinggang mountains, for instance, was an indispensable source of income, hence the trading of ore with non-local merchants in return for certain daily necessities and badly needed medicines for injured soldiers. Over a series of military victories, the Chinese Soviet Republic was declared in the town of Ruijin in Jiangxi from 1931 to 1934, which commanded dozens of border region soviets nationally. This was a turning point in communist state crafting. 

    But these enclaved regimes had to quickly develop commercial and financial ties. The joint-stock Zhicheng Bank in Shenyang is a good example of efforts to accomplish this. The bank was a vital asset of the party struggling to provide the isolated Northeastern Anti-Japanese Aggression Volunteers with medical and arms supplies.19 Just as remarkably, the party ran a commercial station in Hong Kong as a mission facility in the lifeline of its base areas and guerrillas. Qin Bangli, a banker in training and brother of Bo Gu, politburo general secretary from 1931 to 1935, was a “capitalist in practice but communist by conviction” who “scrimped every Hong Kong dollar he could” from business for the revolution while his family lived in a bare rented apartment.20

    Despite a battle for self defense, the red regimes were repeatedly overrun, cut off from one another, and economically strained. The central soviet experienced dramatic shortages and inflation, and consequently its authority had to resort to barter borrowing in 1934. Losing Ruijin to the GMD military extermination campaigns in the same year, the communists embarked on the epic long march and relocated their counter-state headquarters in Yan’an in northern Shaanxi (Shanbei). A special troop of the long marchers shouldered the soviet treasury in gold, silver, banknotes, and minting machines trekked a perilous 6000-mile journey. 

    The relaunch of the soviet central bank in 1935 was based on these capital funds and the reserves of the existing local soviet bank. Soon after the three red field armies joined forces in Shanbei in 1936, they were restructured under the second CCP-GMD united front of the national resistance war and fought the Japanese and their puppet army in the most arduous conditions. By the end of 1945, the communists were in control of vastly enlarged “liberated areas” of ninety million people, or one fifth of the national population behind the enemy lines. Gathering momentum during the civil war, the now renamed People’s Liberation Army (PLA) took offensives to liberate north China and by the early summer of 1949 crossed the Yangzi river to seize the south. The US-backed GMD forces crumbled and fled to Taiwan. 

    The communist managers strove to foster subsistence and commercial agriculture as well as rudimentary industries with a facilitating ownership structure, schemes of subsidies, tax breaks, and other incentives. The red army depended mainly on resources from the battleground but also ran military clothing and munition factories. The “campaign for mass production” in the Shan-Gan-Ning border region from 1940 to 1946 engaged all the government and army units; party and army leaders were each assigned quotas of labor or products to fulfill. This movement ensured that the main communist regional powers would be economically viable. It also initiated a proud tradition of self-reliance and the army’s productive and constructive roles in peacetime. 

    The huge Huaihai campaign in the winter of 1948–49 also demonstrated how the sweeping land reform and related socioeconomic policies decisively changed the outcomes of the war. Thanks to the enrollment of recently landed peasants, the PLA was able to defeat the far better equipped GMD army. Division after division of the GMD army defected to the PLA on the spot, choosing to fight for their own land. 

    Undoubtedly, the fact that the communist local blocs had sustained themselves since the Yan’an era, with some even growing into economic strongholds, helps explain their success. They selectively reappropriated methods from a splendid civilizational tradition and invented their own. A most salient example was the purchasing of harvest in times of abundance and its distribution during lean times. Salt monopoly had also been adapted to manage the market and secure revenue. Though they lack a systematic economic ideology, these policies captured and nurtured market opportunities for common economic life, especially in trade within and beyond their borders.

    Regional communist fiscal and monetary policies

    The communists initially used portable mining machinery to strike coins as the circulating subsidiaries to silver dollars. These became the standard national currency. Although the images appeared crude (see the portraits meant to be of Lenin below), “what these coins may have lacked in appearance, they made up for in integrity.” That is, the communists were honest in their dealings with the peasants, and ensured that their coinage maintained good weight and fineness—in contrast to alternatives which had varied weights and qualities.21

    One yuan silver coin minted in 1931 by the Xiang-E-Xi Soviet in central China

    This applied to the earliest red paper notes as well, which, despite a ragged surface, were promised at full value. Mao Zemin, now the Governor of the Chinese Soviet State Bank founded in 1931, together with Lin Boqu and Deng Zihui, Ministers of Economy and of Finance respectively, devised an independent regional money called guobi in July 1932. With the aim of creating a unified financial system, the Guobi was declared the only acceptable currency for taxpaying and other formal payments. 

    The bank issued public bonds and opened a range of banking businesses of deposit, mortgage, loan, credit funds, bill discount, and remittance in support of the local economy. To strengthen the newly instituted central treasury and secure a source of revenue for fiscal and military expenditures, the financial authority directly operated a state mining company. Most impressively, it also pioneered special trade zones to bypass the anticommunist embargo half a century before China’s reform-era special economic zones. Encouraging the export of cheap local products like grain, timber, paper, and ore, while importing locally wanted goods, the “state bureau of foreign trade” set up multiple offices and warehouses alongside the borders between red and white jurisdictions. 

    The market logic and contradictions within the white regimes thus combined to generate a commercial boom in such places. The neighboring Min-Zhe-Gan soviet also used secrete transportation routes with armed protection and invited outside merchants into its internal markets to boost trade. Its regional bank successfully made government offerings and was able to financially assist the central soviet.22

    Five Fen issued by the State Bank of the Chinese Soviet Republic 1932
    One Yuan “red army notes,” 1934

    In January 1935, the long marchers entered the small city of Zunyi in Guizhou and were stationed there for merely two weeks. They injected guobi brought from Ruijin into the market right away, pegging it to salt, the scarcest local commodity. Backed by the salt reserve seized from the warlords, the “red army notes,” as they were then dubbed, were received as “salt notes.” The purchasing power of the notes for salt and other basic goods was instantly stronger than any other currencies in the local market. Meanwhile, the exchange of red army notes with silver dollars was guaranteed by the soviet bank. 

    The result was immediate and by any account a miracle. With its evident credibility, the new currency stimulated the market, aided the poor, and replenished supplies for an exhausted army. Before leaving the city, the bank opened a number of emergency stores for people to quickly use up their red army notes on materials or silver dollars, achieving almost complete withdrawal of the currency.23 Unsurprisingly, the red banks which already existed in Shanbei had also pegged their currencies to salt. The shared tactic of salt monopoly continued after the arrival of the central soviet.  

    In 1937, the communists formally launched their Shan-Gan-Ning Regional Bank under Cao Jvru’s governorship as the new soviet state bank replacing the Northwestern Branch under Lin Boqu since 1935. Confronted with critical economic and fiscal challenges in a poverty ridden region, and upon the issuing of the new border region banknotes or bianbi in various denominations on paper or cloth, Mao telegrammed the party’s policy leaders on August 17, 1938. He underscored monetary policy principles in the prolonged war against Japanese invasion: local base currency stability, avoidance of  oversupply and hence depreciation; sufficient bank reserves in kind as well as in Japanese puppet notes or weibi and the GMD national fabi; efficient external trade; and sustained army supply. The key was to “keep the value of our regional notes equivalent to or above the exchange rate of Japanese money.” Minor and less dependable currencies were also to be cleared out.24

    1000 Yuan bianbi, circulated in the Shan-Gan-Ning border region in 1943.

    The “foreign” currency of weibi was held as the secondary reserve because “foreign trade” with the Japanese occupied areas was unavoidable for both importing essential industrial and consumer goods and shielding the bianbi against too much fluctuation. As for the fabi, given its domination in the national market as a relatively strong currency backed by the dollar and the pound (after the silver standard belatedly elapsed in China in 1935), it was also a necessary reserve for trade across red-white boundaries.25 After the January 1941 Wannan Incident in which the communist New Fourth Army was unexpectedly attacked and nearly annihilated by the GMD, and with the Japanese occupiers pouring billions of weibi into the market to devalue the fabi, the communists had to alter their monetary policies.    

    Each border region administered its own banking and taxation systems to promote local businesses while countering hostile market manipulations. The regional banks and tax regimes were relatively autonomous in their relationship with Yan’an, due to sheerly uneven economic conditions across regions and individually specific situations in the midst of war and revolution. As the institutions of the state within the state, they constituted a system separate from the national economic and financial jurisdiction. These institutions served as the guardians and facilitators of local economic resilience and hence the viability of the revolutionary bases. 

    In the Shan-Gan-Ning region, government trading companies, such as the mainstay Guanghua Store26 and many cooperative traders, participated in the “financial warfare” waged to defend the bianbi. They furnished vouchers or cash coupons tied to the red money. To strike fair distribution between revenue and tax burdens, the Jin-Cha-Ji border region introduced and amended its cumulative tax rules in the early 1940s. Party leaders and dispatched offices worked painstakingly to design a system of enhancing state fiscal capacity without overburdening common taxpayers.27 To uphold the value of jinanbi issued by the Jin-Ji-Lu-Yu region’s Jinan Bank, the regional government designated “foreign trade” denominated in it as the standard currency, and price control was instrumental for weibi holders to pay more for the same goods.28

    The odds, however, were enormous, and the bianbi did devalue on occasion. Shanbei had been hit by inflation from time to time due to a war racked economy and an adverse balance of payments. The export of salt, oil and other commodities was far from sufficient to offset importing locally unavailable manufactured goods.29 The Jinan Bank was forced to inject extra notes and coins into the market to compete with the fabi and weibi which had been both banned but only ineffectively. They lingered as the bianbi was volatile. To contain the damage, the regional government kept the window of currency exchange legitimately open, while implementing ‘gradient’ rating differentials between the region’s central and peripheral areas. This move at least protected the value of the jinanbi in the core market of the red region and its assets and stocks.30 A more effective way developed only later in the Shandong revolutionary base where the established monetary standards were resolutely abandoned.     

    The Shandong regional Bank of Beihai, established in 1938, had since developed a cluster of divisions alongside the communist military advances in East China. The bank treated commerce as a weapon in the communist hands to integrate production, trade, and finance under a sustainable money and pricing regime.31 Xue Muqiao, chief financial advisor to the regional government in 1943–47, led an expert team to end the constant inflationary threats. The diagnosis was of a persistent inflow of weibi and a collapsing fabi. The Beihai Bank’s beihaibi or beipiao had already been declared the sole base currency in 1942, along with the financial authority’s stated mission of “issuing the kangbi, supplanting the fabi, and prohibiting the weibi.” (Kangbi or “money for resisting Japan” was another name for bianbi and here Beipiao.) This objective, however, did not materialize until nearly two years later, when the government achieved two preparatory objectives: possession of a sufficient stock of essential commodities to back beipiao, and parity of beipiao’s exchange rate for external trade. Steadily earning popular confidence and positive convertibility, this regional currency was consolidated to witness “good money driving out bad money.” As public and private traders and fabi holders either spent the money elsewhere or redeemed it for beipiao, the latter’s credibility accelerated. It became the most stable and favorable currency not only locally but also in the surrounding areas. 

    Shandong was a model of communist regional economic governance, where farms, factories, shops, and other market actors came to flourish. Enemy currencies were expelled and trade thrived. The Shandong liberated areas became a resourceful base for the communist victory in the impending civil war. Xue explained this success through a strict limit on the quantity of circulating currencies and the red money’s overpowering market capture. “The law of ‘bad money driving out good ones’ discovered by the bourgeois economists’ could be reversed.”32 The fabi must be locally delegitimized because its ongoing cocirculation would weaken beipiao’s self-defense and material reserves. 

    Ten Yuan and Five Yuan Beipiao issued by the Bank of Beihai in 1940 (below) and 1945 (above) 

    Xue’s theory focused on the “material standard” (wuzi benwei) for paper money as opposed to the “universal gold standard.”33 As mentioned, it was decided that the primary reserve for the bianbi was to be “goods, especially industrial goods.”34 Only with such a material backing could the independently issued local currency hold on value and market confidence. Quoting Marx’s concept of money as commodities’ “general equivalent,” Xue argued that seeing the kangbi (bianbi) as “a castle in the air” without a metal foundation was mistaken. A currency could be pegged to precious metals or any hard currency as much as material goods. What mattered to the locals in the base areas was the worth of money materialized in physical rather than nominal forms. In Shandong, aside from producer goods, grain, peanuts, cooking oil, sea salt, cotton and other livelihood products were “the best guarantee” behind kangbi.

    Responding to an American journalist who asked how beipiao had triumphed, Xue specified that “our material standard meant that we must monitor money supply according to the market demand. For every 10,000 yuan we issued . . . we would use at least 5,000 yuan to procure material goods.” With sufficient material reserves in place, the regional government could be a market regulator and price stabilizer by reflowing money from sales against inflation or increasing money to augment purchases and thereby neutralize deflation.35

    Towards the national planning and market

    The protection and development of independent markets in communist territories required the designation of local base currencies supplied in the right amount at the right times. The red banks functioned as central banks while playing a range of microeconomic roles as commercial banks as well. The Northeast Bank followed this pattern to issue and solidify its dongbeibi after Japan surrendered. The revolution took the whole region in the next few years and turned the northeast into its own gigantic industrial and financial powerhouse. Both Dongbei and Beihai banks had thrived until the end of 1948 when the People’s Bank of China came into being in Shijiazhuang, Hebei, where the CCP leadership was getting ready to enter Beiping (Beijing). Formed through the merger of red Huabei, Beihai and Northwest Farmers’ banks, the communist national bank began to issue the first set of renminbi or “people’s dollars” on the eve of the founding of the PRC. 

    The new state was confronted with economic chaos—acute hyperinflation, urban food shortages, and violent sabotage were symptomatic of a long mismanaged, deeply corrupt, and failing old regime. The crisis intensified with the 1948 GMD reform that introduced Golden Yuan Notes (jinyuanquan) to replace the severely depreciated fabi. Without minimal assurance in fiscal preparation and quantum of issuance, the note depreciated much faster than its predecessor and soon became nearly worthless. Relentlessly and soaring inflation directly contributed to the downfall of the GMD regime. 

    A famous case of communist resolve was displayed in Shanghai upon the communist takeover. In early 1949, the municipal government transported a large quantity of cereals and other basic supplies into the city, bulk buying through government retailers to hasten price increases and then flooding the market with released stocks to bankrupt hoarding speculators. Differentiating between essential or heavy and non-essential or light commodities, the former were protected through a cost-plus formula for the latter. Skillfully utilizing market instruments to simultaneously depress both inflated prices and excess cashflow, the new authority swiftly restored the value of money and economic order.36 Stabilizing the price of grain followed by intermediate consumer goods, the communists seemed to pick up on a traditional practice of purchasing the plenty to be sold in scant times. 

    Winning economic battles nationally allowed coordinated state actions across regions. The wartime experiences proved handily valuable for the new state to manage economic recovery (while sustaining the war effort in Korea). In the process, the communist economic strategists also flouted the logic of a neoclassical postulate by stabilizing the price level before fixing the budget deficit.37

    Overcoming hyperinflation, financial breakdown, and speedy price stabilization also granted the rural powerholders a firm foothold in urban China. The enraged international ruling class had predicted that the rustic reds would not be able to manage large cities and the national economy, but this was soon disproven. 

    A treasure trove

    The demise of the old state and society paved the way for socialist industrialization without conventional market incentives or financial disciplines. Despite policy blunders and serious setbacks, the communist undertaking of “internal accumulation” was spectacularly developmental, both in physical infrastructure and in human development. 

    Today, the importance of fiscal and monetary sovereignty and market stability remain crucial points of contention for developing and transitional economies around the world. Government reserves of essential goods, a public system of regional development banks, and the maintenance of a stable money supply are just some of the communist wartime policy experiments which bear contemporary resonance.

    In reflecting on how the legal tender of bianbi was locally requisite forty years down the line, Xue Muqiao stressed its status as the only circulating currency vigilantly guarded in size and value. “The basic policy of monetary struggle” was to defend and consolidate the autonomy and security of the beihaibi market.38 He contemplated that this understanding should be useful for those postcolonial nations still lacking the means to counteract imperialist money printing machinery, short-term bonds, and contagious inflation. Financial integration at the expense of autonomy in a speculative and crisis-ridden global market can be perilous.39

    Relatedly, the regulation of  money supply continues to be debated. The provisional charter of the Chinese Soviet State Bank stipulated in 1932 that “money must be supplied in line with market demand” and “extremely cautiously” in an orderly manner, as again asserted at the second soviet national congress in 1934.40 In addition to capping the size of currency circulation as an intricate artwork adjusted to changing demands, the rates of currency exchange were also closely monitored. In the 1940s, Zhu Lizhi, one time governor of the Shan-Gan-Ning regional bank had recourse to fiscal flexibility. Reacting to a hazardous budget deficit, Zhu elevated the bar on bianbi supply and encouraged business lending and mortgage loans to both monetize the deficit and provide for entrepreneurial cashflow.41 The one-sided austere methods, as he saw it, could harm liquidity and in turn worsen inflation.42

    State reserves also functioned as a price control mechanism. The material reserves behind bianbi balanced abundance and scarcity in the market and stabilized the currency through enabling government intervention. The financial authority could thus use its discretion to increase goods supply to lower prices against inflation or increase money circulation and buy in goods to hold prices against deflation. This “material standard,” set to constrain money supply and preserve the worth of unit money, was a token of communist financial governance banked on the regional political-legal power. An implication of this novelty in an age of unbridled financial capitalism could be the advantage of a strong real economy, for which the optimal fiscal and monetary means are yet to be worked out.

  2. Profits, Prices, and Power

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    If they are remembered at all, the 1950s are now thought of as a lost golden age of stable growth and political economic consensus. But the second half of the decade saw rising prices, tightening financial conditions, diminished industrial employment, and stagnant investment. With knowledge of the turbulence that followed, historians have increasingly interpreted the economic history of the late 1950s not as a minor aberration to a stable political order but as revealing structural pathologies latent in the twentieth-century industrial economy. If contemporaries did not yet use the word “stagflation,” they might as well have, referring to the decade’s rising prices with terms such as “new inflation” and “recession-cum-inflation.”1  

    Gardiner C. Means was one of the most astute analysts of the policy dilemma created by this anti-inflationary monetary policy. Means owed his original prominence to The Modern Corporation and Private Property, which he co-authored with Adolf Berle in 1932. This surprise best-seller popularized the idea that corporate capitalism—specifically, its tendency to separate ownership and management—represented a radical transformation in social organization. The book placed the question of corporate power on the agenda at the depths of the Great Depression, and Means parlayed this commercial and intellectual success into a position at the Department of Agriculture in the first Franklin Roosevelt administration. The New Deal’s response to that conjuncture was in part shaped by his distinctive analysis: the length and depth of the 1930s recession was, he argued, a consequence of an imbalance in relative prices between economic sectors—a diagnosis which prescribed national economic planning to raise agricultural prices and allow farmers to afford an expanded volume of industrial production. 

    Twenty-five years later, Means brought his familiarity with corporate pricing patterns to the distinctive problem of the postwar economy. Between 1955 and 1960, in response to rising prices, the Federal Reserve tried to fight inflation by engaging in their first sustained monetary tightening since before World War II. But monetary austerity constrained investment, employment, and growth. It also achieved at best mixed success on the price front; while production and employment flagged, prices did not fall. As unemployed workers, struggling farmers, and Cold Warriors with an eye on Soviet growth rates acutely felt the costs of the Fed’s tightening, Democratic Party strategists sought to unite these groups into a coalition that could in 1960 break the eight-year Republican hold on the White House. Reflecting these social and political energies, Congress held a series of continuous hearings between 1957 and 1961: in the Senate on “Administered Prices” (1957-61), in the House on “Proposed Price and Wage Increases” (1958 and 1959), and in the Joint Economic Committee on both “The Relationship of Prices to Economic Stability and Growth” (1957-58) and “Employment, Growth, and Price Levels” (1959-60).  

    The star witness of each of these hearings was none other than Means, then serving as Associate Director of Research with the business-sponsored Committee for Economic Development (CED). “Clamping down on the volume and availability of credit [is] too blunt an instrument for dealing with this type of price rise,” the editors of the New York Times noted in response to the hearings. “If applied with sufficient vigor [tightening] can slow down the whole economy and produce widespread disemployment.” The excerpts below, taken from his various lectures and testimonies to Congress in this period, republished in 1961 and republished here for the first time in over six decades, offer a glimpse of the expansive possibilities at the beginning of the 1960s. This represented a time when a business-sponsored economist could reject the efficacy of monetary deflation in pursuit of price stability and suggest reforming corporate behavior as the solution to the problem of inflation in the American economy. 

    The program suggested by Means was not seriously taken up—neither by the incoming Kennedy-Johnson administrations, who preferred voluntary guidelines to new legal institutions, nor by the Nixon administration and those who followed, for whom federal price regulation proved a taboo too strong but for the most extreme and temporary emergencies. As the resultant de facto policy instrument, however, monetary policy geared to internal prices had cascading consequences: from attracting foreign capital into dollars and shifting exchange rates, to precipitating financial crises in Third World sovereign debt and domestic Savings and Loan depository institutions. Means’s diagnosis of the roots of inflation in corporate behavior point away from the necessity of such monetary measures.

    As Americans in the twenty-first century return to the dilemmas of a high-pressure economy, Means’s insights into the methods and implications of corporation pricing make him once again our contemporary.  

    — Andrew Yamakawa Elrod

    The excerpt below is taken from Mean’s various testimonies to Congress in 1957 and 1959, and republished in 1961.2

    Monetary policy and administrative inflation

    Just what was the effect on inflation of the tight money policy from 1955 to early 1958? In late 1955 and early 1956, it may well have served to prevent a demand inflation which would otherwise have occurred, although demand, in fact, did not rise to the extent required for full employment. In the latter part of 1955, there was a high demand for credit, partly to finance the heavy volume of auto purchases and partly to finance capital expansion by business. This tended to lift interest rates above their 1953 levels. . . . However, this action did not prevent administrative inflation.

    After early 1956, the situation was quite different. By the spring of 1956, manufacturing demand was easing off, particularly for durable goods other than steel, which was being accumulated in anticipation of a strike. As we have seen, at no time after the spring of 1956 was demand sufficient to push manufacturing production significantly above its highest 1955 level in spite of surplus labor and productive capacity. The further tightening of monetary policy after the spring of 1956 was thus effective in limiting demand. But, because there was no initial excess in demand, the further tightening of policy inhibited growth in the presence of unused resources, while administrative inflation continued.

    Then, in the summer of 1957, when there were ample signs that demand was steadily weakening relative to normal growth, the extreme tightening of money was a shock to the business community that could well have initiated the sharp recession which followed and, along with the previous tightening, have been its primary cause. The recession brought a fall in market prices which masked the continued administrative inflation but did not halt it.3

    The conclusion seems inescapable that a tight monetary policy cannot stop administrative inflation without creating excessive unemployment, and may not be able to do so even then. In the last three years, the effort to control administrative inflation by a tight money policy appears to have cost the nation at least $70 billion of national production (at 1958 prices) which would have been available if that demand had not been so curbed by the tight money policy that a significant amount of manpower and industrial capacity was idle. Whether the administrative inflation during the period would have been greater if a full-employment monetary policy had been pursued is open to debate.

    It is easy to see why the Federal Reserve Board continued its tight money policy after the spring of 1956. The wholesale price index continued to rise and the consumer price index began to rise in the summer of 1956. In traditional economic theory, rising prices are an indication of excess demand. An undiscriminating analysis of price movements seemed to confirm the general character of the inflation. And the concept of an administration inflation was not then [in 1956] current.

    However, suppose that the Federal Reserve Board had been given an analysis showing that after the spring of 1956 there was no demand inflation, that neither labor nor plant capacity was being fully utilized, and that administrative inflation was under way. Consider the dilemma which would have faced the Board: Should demand be expanded so as to bring about full employment while administrative inflation continued; or should demand be contracted in an effort to prevent administrative inflation even though this meant excessive unemployment?4 This would have been an awful choice and there is a good deal of question whether such a momentous decision should rest with the Federal Reserve Board . . .

    A Congressional directive to the Federal Reserve Board

    At the present time there is great ambiguity as to the responsibility of the Federal Reserve Board with respect to inflation. The Employment Act of 1946 places on the Board (as on other agencies of Government) responsibility to aim its policies at “maximum employment, production and purchasing power.”5 It is generally accepted that there is an implicit directive to maintain price stability. Since the Board does have the powers which could prevent demand inflation but cannot control administrative inflation without creating excessive unemployment, the directive to aim at both employment and price stability involves some measure of contradiction. This contradiction could be removed by a Joint Resolution of the Congress, which would:

    1. Distinguish between demand and administrative inflation.

    2. Absolve the Federal Reserve Board from responsibility for controlling administrative inflation and reiterate its responsibility for aiming its policies toward achieving high employment and preventing demand inflation.

    3. Accept the responsibility of the Congress to find other ways to prevent serious administrative inflation.

    Since the Federal Reserve Board is a creature of the Congress, a Joint Resolution would be a command to it. Moreover, a Congressional discussion of such a resolution could be very educational even if the resolution were not passed. Such a discussion alone might be sufficient to clarify the responsibility of the Reserve Board.

    With such a clarification of objectives, the Board could adopt policies which would bring about the expansion in demand required for full employment without demand inflation, while other measures were adopted to prevent serious administrative inflation. The Board already has ample powers to prevent the expansion of demand from becoming excessive and creating demand inflation.

    Public hearings to check administrative price increases

    There are before Congress several bills which would authorize one Federal agency or another to hold public hearings on any prospective price increase which appeared to threaten economic stability. Enactment of such legislation would provide a check on the tendency to raise prices by administrative discretion. Price and wage controls in peacetime should be regarded as a last resort, to be considered only if other measures have failed. But public hearings on prospective or actual price increases, and where necessary on wage increases, could serve a very useful purpose where there was serious danger that such increases would threaten the stability of the economy and impede economic recovery.

    A large number of such hearings would not have to be held in any one year. Authority to hold hearings could be expected to reduce somewhat the enthusiasm for raising prices, and a few important hearings could do much good. The disclosure of relevant data on costs, wages, productivity, etc., would allow the public to discuss on a factual basis the legitimacy of price increases and bring home to those in control in the concentrated industries the policies which would represent responsible behavior toward economic recovery. Such hearings would not be a powerful tool, but rather a valuable aid both in slowing up administrative price increases and in educating the public to the significant issues.

    An anti-inflation tax to reduce incentives for price increases

    The incentive to increase administered prices in order to increase profits could be greatly reduced by a graduated anti-inflation tax. The evidence presented before the Senate Anti-trust and Monopoly Subcommittee makes it clear that the concentrated industries are the chief source of administrative inflation. Therefore an excess profits tax limited to the larger corporations, perhaps those with assets over $100 million [today’s top TK corporations by assets have over $TK billion in assets – AYE], could be effective. Presumably it would only be operative for profits above an ample rate of return on capital and then would take an increasingly large proportion of the excess as the rate of return was higher. Such a tax would reinforce the effect of hearings on specific prices. . . .

    An easier money policy

    The fourth requirement in this recovery program would be an easier money policy. So long as the Federal Reserve Board thought that it was dealing with a demand inflation, it had reason to pursue a tight money policy. And when its leading economists came to recognize the administrative character of this inflation, the Board faced the dilemma already outlined. But if the Board were relieved of responsibility for combatting administrative inflation and steps were taken to check administrative inflation such as the public price hearings and the anti-inflation tax suggested above, the Board’s course would become clear. . . .

    Originally delivered as a lecture during the dedication of a new Law Building at Ohio State University in April 1960, Means’s paper on the legal implications of economic power proposes a reform of corporation law governing management that he suggests would eliminate the incentives to withhold capital investment—even in the face of high prices and profits. The text has been lightly edited for clarity.6

    Pricing in theory and practice

    Here we come to a second failure of traditional theory—the failure of both economic and legal theory to deal adequately with market power in the presence of competition.

    Up to a generation ago, economic theory drew a sharp distinction between competition and monopoly. Either an industry was competitive and the benefits of classical competition were presumed to flow, or it was subject to monopoly with results likely to be detrimental to the public interest. Legal theory paralleled this analysis and supported anti-trust laws to break up monopoly where it appeared “unnatural” and supported government regulation where monopoly appeared to be “natural.” What both systems of theory failed to recognize is that competition among the few is not likely to produce the results in the public interest which could be expected from competition among the many. Neither economic nor legal theory took account of competition among the few. Conceptually, competition was the classical competition of Adam Smith and Alfred Marshall. And the legal efforts to maintain competition were outstandingly successful in preventing monopoly and outstandingly unsuccessful in maintaining or establishing classical competition. The result is that most of manufacturing industry is today dominated by the “big three” or the “big four” actively competing with each other but with effects quite different from those to be expected from classical competition.

    Both theory and current empirical evidence support quite a different approach. In the typical big business situation there are two considerations which appear to dominate the administration of prices. First, it is important to a big enterprise that, as far as possible, the minutiae of pricing decisions be delegated to subordinates with only the crucial decisions made by top management. And second, the main consideration in the actual price is not the price which will yield the maximum profit, but the price which will keep down new competition and yield the maximum value. As we shall see, maximum profit and maximum value are two quite different objectives and each involves quite a different calculus. One is focused on demand and costs; the other on rates of return which will induce or keep out new competition. In the first, the problem is to determine the maximum profit. In the second, the problem is to determine the optimum balance between a higher or lower rate of return and a greater or less risk of new competition.

    As far as I know, the first logical presentation of this pricing calculus was made, not by an economist, but by a management engineer. In 1924, Donaldson Brown, then with DuPont and later a Vice President of General Motors, outlined a pricing procedure which is now extensively used by big manufacturing enterprises.

    Because this pricing calculus is so different from that derived from monopoly theory and because it opens up a new possibility for corporate management, I want to list the five steps which it involves.

    The first step is to determine a rate of return on capital which will represent the optimum balance between high returns and the risk of new competition. This is called the target rate of return. General Electric, General Motors, and presumably, DuPont, each appears to use a target rate of 20 percent after taxes in their pricing. [General Motors still earned 19 percent returns on equity after the Johnson administration negotiated a reduction in prices on 1966 models.—AYE] Union Carbide appears to use 18 percent after taxes, Johns-Manville, 15 percent. US Steel formerly appeared to use eight percent after taxes, but a few years ago revised its target rate upward considerably. It may now be close to 15 percent. Whatever the basis for selecting the target rate may be, forecasts of cost and demand do not enter into this step in the calculus.

    The second step is to adopt a “standard rate of operation” for pricing purposes. This may be the actual average rate of operation over a period of years or a rounded figure close to the actual experience. Thus, if an enterprise finds that in the past, with the ups and downs of business activity, it has operated its plant at close to 80 percent of rated capacity, it is likely to use 80 percent as its standard rate for pricing purposes.

    The third step is to estimate the average cost of production per unit, if the enterprise or the particular plant were operated at the standard rate of operation, say 80 percent of capacity.

    The fourth step is to figure what price would have to be charged, in the light of these costs, if the target rate of return were to be made when the company or plant operated at the standard rate of operation. This can be called the target price.

    It should be noted that up to this point in the pricing process no consideration at all has been given to the demand for the product. Only at the fifth stage is demand introduced into the calculation.

    In the fifth step, the market is examined to see what volume of sales could be expected at the target price. If the market survey indicates that, under average market conditions, the sales at the target price will be just about equal to production at the standard rate of operation, then the target price will be adopted as the price.

    If the market analysis indicates that a larger amount could be sold at the target price, the enterprise will not usually set a higher price since this would produce a rate of return higher than the target rate and attract new entrants. Rather, it will adopt the target price and immediately start expanding its facilities so as to supply the larger demand.

    If, on the other hand, the market analysis shows that, under average conditions, demand at the target price will not allow the standard rate of operation, then the management is faced with two alternatives. It can decide not to make the product on the ground that it would not yield the target rate of return, or it can decide to set a lower price and institute a major drive to reduce costs of production of the particular product in order to earn the target rate of return at the lower price.

    The sharp contrast between this pricing calculus focused on a target rate of return and the traditional calculus focused on demand and cost must be obvious. Target pricing starts with the target rate of return and works from that to costs and demand. . . . In contrast, the traditional theory starts with demand and costs. . . .

    The target pricing technique may not be rigidly adhered to and different target rates of return may be applied to different lines of product by the same company. It does, however, provide a logical pricing technique and empirical studies have shown that in the United States it is [was, at least,] employed by the price leaders in many concentrated industries such as chemicals, automobiles, steel, electrical equipment, construction materials, and agricultural implements. It helps to explain the inflexibility of administered prices which has come to be such an important aspect of the American economy.

    Profits and the public purpose

    Of immediate importance for our present discussion is the economic power reflected in target pricing. The purpose in target pricing is to obtain a rate of return above the competitive cost of capital but not so much above the competitive cost as to stimulate new competition. The more difficult to enter an industry, the greater the discrepancy between a competitive rate of return on capital and the target rate that can be successfully achieved. A target rate of return of 20 percent after taxes would probably represent more than double the competitive cost of capital. The public utilities whose prices are regulated to allow only six to six and a half percent return have had no difficulty in raising new capital for expansion. . .

    What does this mean from the public point of view? It means that the drive for profits in these great collective enterprises does not serve the public interest. In three important ways the profit objective as the guide to operations conflicts with the public interest.

    First, prices result which are above the economic costs of production and profits are above the economic cost of capital. This represents a distortion in income distribution which may or may nor be socially important.

    Second and more important, this exercise of pricing power aggravates labor-management relations. Excessively high earnings on capital offer a constant target which in a sense justifies pressure from labor for increased wage rates. At the same time the focus on the drive for corporate profits amply justifies labor’s adoption of the same drive to get higher wages.

    Third, and in my opinion most important of all, a high target rate of return means that the collective enterprise is not making full use of its potential. If a big corporation, despite its great resources of technology and organization and access to capital and labor, will make only those things which will yield a 20 percent return when it can get capital funds for 8 or 10 percent, an economist must say that it is not serving the public interest as it should, or more exactly, as it would have to if it were subject to classical competition. And if a big corporation will replace existing plant and equipment only when the new will make 20 percent on the investment, it will fail to make full use of modern technology. . . . From the public point of view, the drive for corporate profits is not a satisfactory guide to the operation of the big collective enterprise. . . .

    What, then, can take the place of the drive for corporate profits? I believe there are two institutional changes which, in combination, would provide an effective alternative.

    The first depends on the target techniques of pricing. So far as the mechanics of target pricing are concerned, the actual target rate of return is not important. The pricing process would be essentially the same whether the target rate adopted was 20 percent or ten percent or eight percent. If top management found that adequate capital could be obtained . . . when an average of eight percent on capital was earned after taxes and if it adopted eight percent as the target rate, the rest of the pricing process would follow and prices would tend to correspond to average economic costs.

    Under given economic conditions a lower price would result in a greater volume of sales and require a greater plant expansion. This would reflect the more effective use of resources. Also, it would give legitimacy to management in its demand that labor be reasonable in its wage demands, a legitimacy that is certainly lacking when management is under a drive to make more profits.

    However, while a target rate of return geared to the actual cost of capital would be an effective guide to pricing, it would not provide the other pressures for economical operation which is provided by corporate profits. . . If the objective of the game is to make profits, then prestige and satisfaction depend on making profits. But if the objective of the game can be redefined, then prestige and satisfaction in accomplishment need not be tied to corporate profits.

    Money rewards to management also do not need to be tied to corporate profits. Many corporations now have two bonus systems, one for top management that is geared to corporate profits, and the other for lower levels of management that is geared to performance. . . . I believe a system for performance bonuses for top management could also be worked out. Such a system would be tied to the setting of target rates of return on the basis of capital costs. It would presumably include bonus payments for cost reduction, product improvement, research and development, and for other such items of good management as could be effectively measured. . . .

    However, there is one problem with respect to bonuses that we do need to consider. This is the effect of income taxes on bonuses.

    In the past, most of the big companies have given cash bonuses to top management for increased profits. But with high income tax rates, cash bonuses have very little incentive power. A high-salaried executive is [read: was] likely to pay most of any cash bonus to the Federal government. If the president of a big company receives $200,000 as a salary [about $2 million today] (more than half already going to the government [under the 1960 income-tax schedule]) a bonus of $200,000 is likely to net him only $18,000. As a result, many corporations have adopted a stock option plan whereby the top officers are given rights to buy stock from the corporation at the market price prevailing at the time the right is given and good for a period of years. If the stock rises in price and the option is exercised, the gain from the sale of the stock after six months will be taxed as a capital gain. Such options place top management under great pressure to increase profits so as to raise the market value of the stock and obtain income not subject to the very high tax rates.

    If cash bonuses for performance are to be substituted for profit bonuses and made effective with top management, changes in tax law would be needed to increase the take-home pay from such [performance] bonuses [in exchange for public regulation of target rates of return] . . . The real legal question is whether, with such legislation in operation, the adoption of the dual program by management could be overturned in the courts. As I envisage the tax law, it would provide a big inducement to management to adopt the performance bonus system, particularly if the same legislation removed for collective enterprises the capital gains provision associated with stock option bonuses. But it is difficult for me to find any great advantages to the stockholders . . .

    On what basis can the stockholder be made to have an interest in putting such a dual plan into effect or be forced to accept such a plan?

    Here it seems to me we break into new legal ground—or perhaps, as a non-lawyer, I should say here is where I get out beyond my depth. If I have analyzed the economic problem correctly the rates of return on capital are currently too high for the public interest to be fully served because there is neither public regulation nor a close approximation to classical competition. From the public point of view, the stockholders are getting returns out of proportion to their contribution . . . and the public problem is to bring these returns down.

    One way to do this would be legislation which delineated the class of collective enterprises, denominated them as vested with a public interest and required them to use a target rate of return related to their costs of capital. Such legislation would not be nearly as difficult to police as direct regulation and would give much more freedom of action to the individual enterprise. Also, if a legitimate target rate of return was required, then it would be in the interest of both stockholders and management to adopt a performance bonus plan provided it included a bonus for making the target rate.

    The question is then whether such legislation could be successfully defended in the courts. I suppose that the strongest line of defense would be that these collective enterprises are so big that competition does not adequately control their behavior and that they involve the life and property of so many people that the have become vested with a public interest and are therefore subject to regulation, and that the type of regulation involved in the legislation is a mild form indeed. Would it strengthen the legal case to point out that the stockholders had surrendered practical control over the enterprise and therefore were not entitled to more than the wages of capital? Would it strengthen the legal case, if instead of requiring the adoption of a legitimate target rate of return, the stockholders were given a choice of (1) accepting the status of a collective enterprise with all that implies, or (2) breaking the enterprise up into smaller units so that it was beneath the size and importance which gave it the vestments of a public interest?

    In The Modern Corporation and Private Property, Berle and I suggested that the separation of ownership and control made both the logic of property and the logic of profits inapplicable to the modern corporation and that corporate developments “have placed the community in a position to demand that the modern corporation serve not alone the owners or the control but all of society.” I now suggest that target rates of return based on the cost of capital and suitable bonus plans based on performance would go a long way toward meeting this demand. As an economist I look to the law to make this possible.

  3. Cash, Cars, Chemicals (and Corn)

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    This is the tenth edition of The Polycrisis newsletter, written by Kate Mackenzie and Tim Sahay. Subscribe here to get it in your inbox.

    Decarbonization—reducing the output of invisible CO2 molecules into the atmosphere—requires nothing less than remaking the chemical basis of fossil fuel civilization. The energy transition from an economic system run on fossil-fuels into a new metals-based one will reshuffle winners and losers, and blow up both domestic and international political orders. The major decarbonization plots unfolding globally are in the realms of cash (green finance), cars (EV growth), and chemicals (battery production). Inspired by energy finance analyst Nathaniel Bullard’s tour-de-force presentation illustrating the white-knuckle ride of the energy transition, this week’s newsletter picks out a few big charts that get at the antinomies of these three processes.


    Not so long ago, one trillion dollars in annual global green investments was the goal. We are now there:

    But the energy transition requires stamping on the brakes of fossil fuels and the green accelerator. The largest banks in the world still lend more money to fossil fuel projects than clean energy projects. The money that has flowed into green investments so far concentrates on two destinations: renewable energy generation and the auto sector: 


    Road transport is responsible for about one fifth of all energy-related CO2 emissions and a large proportion of harmful air pollution. For many governments, the auto sector is also a powerful political constituent and a key node for economic growth and industrial strategy. Moreover, as the largest chunk of cross-border traded goods, the car itself is an emblem of globalization

    The essential questions are: Who makes them, and who feeds them? Until recently, the first question could be easily answered: Japan, Europe, and North America. In the case of the second question, the answer was simply crude oil from the US, the Middle East, and Russia. But in the past five years, a seismic shift has taken place in the industry: China overtook Germany to become the biggest exporter of passenger cars in the world.

    A lot of that growth came from Tesla’s factory in Shanghai. But look around you. Most people in countries like the US have never seen a Chinese-made car. For all the talk of post-Fordism, global production of internal combustion engines is at an all time high. There are over 1 billion cars on the roads. That’s over 280 million cars in the US, China and EU each. In the US, EV sales are at just 5 percent. In China, the figure is 20 percent, and in the EU, 10 percent.

    Every manufacturing power—and every aspiring manufacturing power—now has overcapacity issues, having over-invested in internal combustion engines. As sales of EVs boom, those stranded assets and lost jobs will find political champions.

    The days of internal combustion engines may be numbered, but we should expect the unexpected. Just this week, German liberals and Italy’s far right pushed back on a proposed EU ban on internal combustion engines by 2035. The entrenched car industry is going to rage against the dying of the light. 

    The formidable political power of the gas car bloc, and the centrality of cars to American life in particular, provides the terrain for further surprising and climate-devastating sectoral politicking. In the US, big farms have turned out to be more powerful than even the fearsome oil lobby. How? Simple math, as Senator Bob Dole once suggested: twenty-one farm states equals forty-two farm senators. Each time oil prices spiked—in the 1970s, in 2000s, and once again in 2022—those senators made a deceptively simple argument: replace expensive imported gasoline with domestically produced corn ethanol. Yes, corn in cars. 

    In 2007, these senators secured the passage of the Energy Independence and Security Act. It mandated that 10 percent of every gallon of gas has to be made from corn ethanol. Its ramifications literally terra-formed the world. 

    BigAg wasn’t done taking sales of petrol away from BigOil. Cheaper ethanol from higher-yielding Brazilian sugarcane was blocked by tariffs, and prairies in the upper Midwest were furiously plowed into cornfields. By the mid 2010s, almost half of all US corn crop was turned into ethanol. So began the search for a cheaper oil for food. The resulting explosion in palm oil production included a plantation boom in the rainforests of Indonesia, which required the slashing and burning of rainforests, and unstoppable peat fires. The 2015 Indonesian fires produced over a billion tons of CO2 and rank among the worst environmental catastrophes of the twenty-first century.


    If not planet-changing oil and corn, which chemicals will feed cars? Most of the batteries in EVs—and your smartphones and laptops—are Lithium-ion. Their cathodes are made with nickel, manganese, and cobalt (N, M, and C). An NMC battery provides enough energy density to drive you 300 miles (480 km) on a charge. They had been getting monotonically cheaper with economies of scale and better chemical engineering. But in the past year, for the first time in decades, they started to become more expensive.

    Why? Firstly because nickel is mined primarily in Russia and cobalt in the Democratic Republic of Congo. Sanctions against Russia and child labor in the DRC pushed companies to seek alternatives; the auto sector also had concerns about occasional but catastrophic NMC battery fires and the short lifespan of only about a decade. 

    China is leapfrogging the world in battery innovation. Tesla and China’s BYD were among the first EV makers to switch to LFP batteries when nickel became expensive in 2020. The cathodes of an LFP battery use abundant iron (Fe) & phosphate (P) instead of scarce and expensive cobalt & nickel, and have a shorter range than NMC but faster charging. Since the switchover began, LFP’s market share has nearly tripled. In a reversal of decades of green tech knowhow flowing eastwards, Volkswagen in EU and Ford in the US are racing to license LFP battery technology in on-shoring tech-transfer deals with the Chinese battery giant CATL.

    Then there is sodium ion: a possible new contender (table salt in cars!) that is cheaper, if for now less energy dense. India’s Reliance bought Faradian last year, while rumors and reports in the EV trade press suggest China’s CATL and BYD are close to selling passenger cars with the much cheaper Na-ion batteries. As commercial competition for the $46 trillion EV market heats up, we can expect automakers to push for battery regulations that hide protectionist aims in recyclability and recoverability standards for certain battery chemistries.

    The energy transition is the site of conflict between an old world anchored in stocks and flows of hydrocarbons, and a new world dependent more on manufacturing processes and genuine innovation in energy.

    Fears about supply shortages of transition minerals need to be seen against the image of past predictions of cobalt shortages, and the tiny scale of transition minerals versus fossil fuel extraction.

    It is true: the energy transition is going to require more mining. But it’s going to be so much less mining than one year of mining coal. An average car burns 17,000 liters of petrol over its life, equivalent to a 25 storey high stack of oil barrels. A EV “consumes” (i.e. after recycling) around 30 kilograms of metals, about the size of a football. 

  4. Wall Street Consensus a la Française

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    Since his election in 2017, French President Emmanuel Macron has periodically committed to resetting France’s relationship with Africa. In 2020, his so-called Macron Doctrine denounced the Washington Consensus for creating a “capitalism that has become financialized, that has become over-concentrated, and that is no longer capable of handling the inequalities in our societies and internationally.” He called instead for a Europe-Africa partnership of equals to underpin the material and ideological work that would reverse financialized capitalism and its destruction of the climate. 

    Then, in October 2021, he hosted the Africa-France summit in Montpellier. Under the guise of “reinventing” the relationship between France and its former colonies, Macron decided not to engage with African heads of state as usual, but rather with a new body of “civil society” figures that he had assembled, ostensibly representing the continent’s peoples and “the African youth.” More recently, ahead of a Central African tour this March, Macron promised that France would be more “humble” towards an African continent that is no longer a “private backyard” or a “competition ground.” He would create a legal framework for the restitution of African stolen artifacts and shrink the French military presence on the continent, in light of its failure in the Sahel region and the growing resentment it fed there. Macron also reminded the world that France’s climate partnership with Africa was making good progress. In particular, he highlighted the One Forest Summit (OFS) co-hosted by France and Gabon in Libreville on March 1 and 2, the first stop on his African tour. 

    The OFS aims to create an institutional framework for protecting tropical forests that help absorb carbon emissions and preserve biodiversity. France plays a pivotal role, co-chairing with Costa Rica the High Ambition Coalition for Nature and People (HAC), an initiative launched at the One Planet Summit in 2021. The coalition of more than 100 states vows to protect 30 percent of the world’s land and sea by 2030. In Libreville, at what participants termed the Implementation Summit, the OFS presented its three-pillar strategy for forest protection: unlocking innovative sources of funding via (voluntary) nature markets, fostering sustainable value chains, and promoting scientific cooperation on rainforests. 

    It is in the first pillar—promoting biodiversity-positive carbon credits and nature certificates—that Macron’s African agenda reveals itself for what it is: the French arm of the Wall Street Consensus, the derisking-as-development paradigm. In partnership with a choir of derisking evangelists that includes multilateral development banks like the World Bank, conservationists, philanthropists like the Bezos Earth Fund, lobby organizations like Nature Finance, and (French) financiers like Meridiam and Mirova, Macron is promising delivery from deforestation, biodiversity loss, and even sustained fossil fuel consumption. His plan aims to meet these ambitions through innovative market instruments that promote private investment in nature, turning it into an asset class in an “investability” partnership with the state.  

    The derisking evangelists that Macron accompanies to Gabon are not unlike the missionaries of the colonial period. Then, the great Burkinabe historian Joseph Ki Zerbo once remarked, the historical sequence of colonialism involved Merchants, Military, and Missionaries. French missionaries in the nineteenth century actively cooperated in the imperial expansion of France in Africa, “ardently patriotic, eager for government subsidies, and cognizant of the benefits for their work in the colonies and foreign territories that would accrue from government support, ardently courted government favor.” A similar logic animates derisking evangelists today. Under Macron’s protective shadow, they have contended with the systemic greenwashing hardwired in the production of nature asset classes by producing the narrative of a bumpy road towards the inevitable achievement of equitable, nature-positive outcomes. But the broader strategic aim behind this narrative is the construction of the visible derisking hand of the state—the roll-out of the Wall Street Consensus. The aim is to refashion the state to scale up the financialization of nature mainly for the benefit of global North capital.

    Setting the scene: the One Forest Summit in Françafrique Gabon

    Gabon gained its independence from France in 1960 but continues to maintain neo-colonial relations with the former metropole. French armed forces remain in the country, notably to “secure” the dynastic regime—first of the now deceased Omar Bongo Ondimba, former friend, advisor, and electoral financier of French politicians, and now his son, President Ali Bongo Ondimba—from a population that might vote for a democratic move away from the neocolonial order. France’s interests there are economic: among the top five oil producers in Africa, Gabon remains a member of the CFA franc area, and supplies France with three main types of products: natural hydrocarbons, metal ores (manganese), and wood. The Franco-British group Perenco, France’s number two oil company, has been the main oil company in Gabon since it bought some assets from Total in the 2010s. The Compagnie Minière de l’Ogooué (COMILOG), which is 63.7 percent owned by the French company ERAMET, extracts 90 percent of the manganese from the Gabonese subsoil. 

    Some environmental activists, such as Bernard Christian Rekoula, who had to leave Gabon for fear of persecution, see the OFS summit as a full-scale “greenwashing” ceremony. By contrast, the OFS documents and participants downplay greenwashing as unavoidable, part of the process of leveraging the necessary private resources for biodiversity.

    Derisking evangelists on greenwashing: bumps in the road

    Voluntary nature markets have recently become fashionable tools to safeguard and restore forest ecosystems for “environmental, economic, cultural, and social benefits.” Their necessity is constructed as a macrofinance question: financiers computed a yearly USD 200 billion “nature financing gap” up to 2030 and claimed that it cannot be covered by public resources. Instead, scarce fiscal resources should be “used wisely to catalyze additional private finance and increased action and effectiveness,” to quote the Innovative Finance for Nature and People Report prepared for the One Forest Summit. Catalyze is a synonym for derisking: the market on its own cannot conjure the financial instruments that would generate, at timely scale, the resources to fill in that gap because risk-adjusted returns are not attractive enough for private investors. As the price signal fails, the state intervenes to “derisk,” that is, to introduce fiscal or regulatory interventions that steer the price signal in nature markets, including voluntary markets, towards a level better aligned with investor preferences. 

    The logic at the core of the voluntary nature markets is that participants trade “credits” which are issued to value (or monetize) conservation interventions that “increased CO2 removal or reduced emissions commensurate with the number of credits issued.” Buyers—say, large corporations with net-zero commitments—can then claim to be voluntarily offsetting their own carbon footprint by investing in the protection and restoration of biodiversity elsewhere. 

    Rather predictably, the incentives at play are for certification agencies, issuers, and buyers to engage in systemic greenwashing. For instance, a recent Guardian investigation revealed that only 10 percent of the carbon credits issued by Verra, the world’s leading carbon standard setter for the voluntary offset market, had a verifiable claim to have removed or decreased CO2 (or additionality). The rest were greenwashed “phantom” credits. 

    To its authors’ credit, the OFS Report accepts greenwashing as legitimate criticism of voluntary markets. It also stresses the importance of genuinely involving indigenous communities, another matter of substantive critique towards nature as an asset class projects, presumably responding to challenges from environmental organizations like Survival International, who have termed the Conservation Agenda as “new green colonial rule,” and to research that uncovered the militarism and violence against grassroots communities and their management practices. Indeed, African indigenous communities have opposed land-grabbing exercises that seek to commit African countries to set aside between 35–42 percent of their national territories exclusively for wildlife and biodiversity (compared to 12.45 percent in the US).

    Despite this acknowledgement, the OFS report maintains such problems are “growing pains” to be overcome by a stronger institutional framework for certification and monitoring, and by innovative financial instruments like nature certificates that do not rely on complex additionality modeling but instead strive to provide the buyers with “entirely positive contributions to biodiversity.” (A recent paper by Katie Kedward and colleagues argued that the high transaction costs associated with rigorous regulation of nature markets are fundamentally at odds with competitive returns and scalability.) On the first day of the summit, difficult questions were handwaved away, with the notable exception of the Costa Rican delegate. 

    Scaling up the visible derisking hand of the state

    The finance discussions on day one of the summit focused on the question of scalability. These echoed concerns that the growing controversies around greenwashing were further threatening the already limited incentives that corporations had to massively scale up demand for credits and certificates to the hundreds of billions in private financing promised in climate fora. The CEO of the lobbyist organization Nature Finance (and until recently Sherpa of UN Secretary General’s Task Force on Digital Financing of the Sustainable Development Goals) Simon Zadek lamented that “voluntary demand will not deliver timely scale.”  

    The solution, Zadek suggested, was to recognize “the need to set prices through a policy architecture rather than a market architecture.” In other words, voluntary markets for credits and certificates were destined to fail on their own, unable to generate the price signal that would attract demand and increase volumes traded to the ambitious levels set out in the “financing gap” discourse. The state would have to step in with a policy architecture that could make the numbers work for private investors.

    This call perfectly encapsulates the logic of the derisking state as a set of interventions that tinker with price signals at the asset level, of institutionalizing practices for shifting price signals to both facilitate capital accumulation and rationalize (financial) capitalism. In essence, this means fiscal subsidies layered on top of regulations, as the OFS Report spells out: 

    Scaling up demand is a challenge, and rests upon shared and robust principles for defining and verifying credits/certificates, consensus on the proper use of credits/certificates, mechanisms to safeguard the market’s integrity, engagement of new partners, clear long-term demand and price signals, and policy and regulatory mechanisms, including fiscal incentives. While some voluntary schemes, including nature-based carbon credits, have markedly grown in volume and have the potential to further grow, large scale has mainly been achieved as a result of regulations or government financing, underscoring their importance in achieving scale.1

    It is important to stress that regulations can involve both compliance with carbon markets (sticks) and an enabling environment that eases the issuance of credits (carrots). But in Gabon, as elsewhere, derisking evangelists have conjured a state that replicates the price mechanism of a competitive order without disciplining the private recipients of subsidies and guarantees. This “carrots without sticks” strategy at the core of the Wall Street Consensus is increasingly ubiquitous in decarbonization debates and policies, from the US Inflation Reduction Act to the European RePower initiative. Equally important, it aims to displace the demonstrably more effective alternative: the provision of ecological public goods via well-targeted public investments in the environment and its protection

    The One Forest Summit concluded with the announcement of the Libreville Plan. Among its initiatives, the Partnership for Positive Conservation aims to establish the policy architecture for scaling up the market for biodiversity certificates. France, Gabon, and the United Kingdom will together set up an intergovernmental platform to guarantee the environmental integrity of the certificates. On top of regulatory derisking, France, Conservation International, and the Walton Foundation (Walmart) committed to add EUR 100 million in public and philanthropic financing to increase demand for certificates. The visible derisking hand of the state, En Marche!

  5. The IMF Trap

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    Massive demonstrations that swept Sri Lanka last year exposed the serious challenges at the heart of the global economy. In July 2022, former President Gotabaya Rajapaksa was forced to flee the country, only a few months after announcing a hasty default of Sri Lanka’s foreign debt obligations. He faced a wall of opposition as the nation suffered infamous kilometers-long fuel queues, power outages, and food and medicinal shortages, crippling everyday life. 

    In the months since, the current government led by Ranil Wickremesinghe—allied with the party of the disgraced Rajapaksa family—has appeared savvier than its predecessor, implementing a quota system to manage fuel distribution and end the queues. However, the government has also tripled fuel prices, which has severely dampened demand. Fuel consumption is half of what it was a year ago, bringing economic activity to a grinding halt. Inflation has skyrocketed, with food inflation peaking at 94 percent in September 2022. A quarter of Sri Lankans are facing severe food insecurity; household incomes across the board have decreased. The Central Bank dramatically doubled interest rates, making access to credit for economic activity extraordinarily difficult. Rural livelihoods have been disrupted. Many small businesses are collapsing. 

    The country’s default and its remaining pathways forward reveal the fault lines of a messy and intractable process. While the most visible aspects of the crisis that captured the attention of news media last year may have disappeared, the ongoing breakdown points to fundamental flaws in the global economy. These include the lack of a credible mechanism for resolving debt crises in peripheral countries like Sri Lanka, along with the possibility of a lost decade, if not longer, for development in many parts of the world.

    Sri Lanka is already experiencing the unsustainable consequences of an International Monetary Fund (IMF) policy package, though it is yet to receive even the first infusion of IMF funds under a promised agreement of USD 2.9 billion, reached in September 2022. The IMF has demanded that Sri Lanka first obtain assurances from bilateral and private creditors, in addition to developing concrete plans to achieve a primary surplus by 2025 to conform with the IMF’s Debt Sustainability Analysis. 

    The problems associated with the IMF’s policy package have been caught in geopolitical rhetoric. The US alleges that Sri Lanka is the victim of a Chinese debt trap. In fact, Sri Lanka is in an IMF trap. The structural consequences of over four decades of neoliberal policies have exploded into view with the receding welfare state, a ballooning import bill, and investment in infrastructure without returns, all of which relied on inflows of speculative capital. Framing Sri Lanka’s crisis within a narrative of geopolitical competition obscures the core dilemmas of the global economy. Will the evident breakdown force a reckoning with the present order, or will it be used as an excuse to inflict more suffering?

    Foreshadowing the crisis

    The current predicament seems to anticipate a wave of sovereign defaults with consequences as profound as the Latin American debt crisis of the 1980s. That moment signaled the beginning of “structural adjustment” as part of bailout agreements for countries in the periphery. The Bretton Woods institutions—the IMF and World Bank—originated in the aftermath of World War II as part of an attempt to coordinate global efforts to avoid another systemic breakdown. Intensifying debt crises in the 1980s forced a response from the US, which steered the creation of the Brady Plan to help Latin American countries undertake debt swaps. Bailouts from the IMF, however, came with strict fiscal conditionalities, complementing neoliberal policies in the core countries.

    The counter-revolution of capital against labor during the economic crisis of the 1970s included the eponymous interest rate shock introduced by Federal Reserve Chairman Paul Volcker, which increased unemployment and helped break the back of organized labor. Giovanni Arrighi called it the signal crisis of US hegemony, with finance acquiring an increasing hegemonic role in the global economy.1 The boom in financialized speculation occurred roughly over the same period and ended with the Covid-19 pandemic. It trapped more countries in new cycles of volatile financial inflows, encouraged by capital market liberalization, rating downgrades, and renewed austerity. Sri Lanka’s breakdown embodies the terminal crisis of this cycle. 

    Sri Lanka was once celebrated for its high rates of economic growth. The ruling government’s pyrrhic victory against the Tamil Tigers in the North and East in May 2009 saw an expansion in financialization, with the government borrowing more in international capital markets. In response to the 2008 global financial crisis, the US and other Western countries adopted lower interest rates. Yield-hungry capital flowed into emerging markets, including Sri Lanka, eager to cash out on its post-war dividends. The government was led by Mahinda Rajapaksa, Gotabaya’s older brother, whose popularity in the predominantly Sinhala South had soared with the war victory. The Rajapaksa government obtained an IMF deal in July 2009 and promoted a development model that fueled economic growth by investing in large-scale infrastructure, including ports and highways, real estate, and urban development projects. This model was continued by the Sirisena-Wickremesinghe government that came to power in 2015. 

    These policies were the outcome of Sri Lanka’s long experience with economic liberalization. The IMF and World Bank gave the country room to maneuver with populist measures by supporting investment in large-scale infrastructure projects even after liberalization in 1978. However, the emphasis shifted to austerity by the early 1980s. Meanwhile, export industries such as garments did not transition to investment in more capital-intensive industries, becoming yet another export enclave, one of many dating back to the colonial plantation systems. 

    The post-war regime of Mahinda Rajapaksa capitalized on the desire for investment in the rural south. It promoted infrastructure development, which was ultimately predicated on deeper financial integration into the global economy. The model of funding large infrastructure projects by relying on domestic and international capital markets was further endorsed by major multilateral institutions, particularly the IMF, World Bank, and Asian Development Bank. However, the expectations of a post-war economic boom did not last long. By 2016, Sri Lanka was yet again in economic distress, which led it to enter another IMF agreement.

    Indeed, early signs of economic trouble had already emerged by 2014, and provoked rising discontent among ordinary people, contributing to the electoral defeat of Rajapaksa in 2015. A drought in the interim years of the Sirisena-Wickremesinghe government further weakened the rural economy. Finally, the 2019 Easter bombings led to a deterioration in Sri Lanka’s current account, as tourism experienced a significant drop. The final blow to Sri Lanka’s economy came with the Covid-19 pandemic and the tremendous global price hikes caused by the war in Ukraine. The proposed IMF agreement with Sri Lanka would be the country’s seventeenth since 1965. However, the new IMF policy package now prefigures a dramatic change in relations between state and society, greater than any IMF agreement preceding it.

    The IMF path of devastation

    Since the IMF’s initial Article IV Staff Report release early last year, Sri Lanka’s policymakers have already carried out its main recommendations. These measures include raising indirect and direct taxes, implementing cost-recovery energy pricing, imposing fiscal consolidation, hiking interest rates, and devaluing the rupee. Although the IMF also recommended robust measures of targeted social protection, they have yet to be implemented. 

    The evasive rhetoric about social protection raises questions about the IMF’s commitment and the interest of the local economic establishment—including the nation’s central bankers, prominent expert voices, and think tanks—in addressing the tremendous suffering across the nation. Meanwhile, the Wickremesinghe-Rajapaksa government went so far as to criticize the very idea of a food subsidy and relief in the Budget for 2023 presented late last year.2 As a result, the government has abetted what has become a full-on assault on working people’s livelihoods, during an economic depression unseen in the country since the 1930s.

    Sri Lanka’s pro-IMF contingent has argued that raising value-added taxes on goods is crucial, which means increasing costs for items that have already skyrocketed in price. They insist that the tax cuts of the Gotabaya Rajapaksa government in 2019 triggered Sri Lanka’s crisis, an explanation that is part of the justification for reducing the country’s fiscal deficit by rescinding the cuts and increasing taxes in other areas. However, the return to the revenue question overlooks the fact that liberalization had hollowed out Sri Lanka’s tax structure long before Gotabaya Rajapaksa’s rule. For years, indirect taxes have comprised roughly 80 percent of total tax revenue.

    The explosion of imports from the late 1970s onwards had brought in additional revenues from duties, but these have been reduced by the restrictions necessary to conserve foreign exchange during the recent crisis. While prioritizing imports is essential, the desperate lack of other revenue sources has exposed how Sri Lanka’s upper classes have long disproportionately benefited from taxation policies. Indeed, redistributive taxation has all but collapsed. The government has now increased direct taxes on all people earning over Rs. 100,000 per month, but this new policy, focused on income, is a far cry from efforts to redistribute wealth. A truly redistributive approach requires a wealth tax on existing property and assets as well as on conspicuous consumption, such as luxury cars and high-end properties. Such wealth was accumulated through decades of exploitation and extraction by the elite. Sri Lanka’s post-war development model, for example, directly led to the boom in luxury real estate development and the luring of speculative investment, which has now fled the country. 

    In addition, the current government’s attempt to target a fiscal surplus presupposes unprecedented austerity, while an economic crisis is immiserating people. The new income tax initiative is not part of a broader effort to restructure Sri Lanka’s economy along more egalitarian lines, including ensuring relief and investing in a new, self-sufficient development model. Instead, it is part of a misguided attempt to double down on austerity. Finally, the Wickremesinghe-Rajapaksa government lacks the legitimacy to carry out new tax measures in the absence of parliamentary elections. In this context, tax increases are politically explosive, evidenced by growing discontent manifested in new protests.

    While the predominantly urban, professional middle classes are starting to stir, the government has made things worse by trying to implement the IMF recommendation of cost-recovery energy pricing. The resulting increase in prices on fuel and utilities, detailed above, has led to economic distress for various demographic sectors, including farmers, fishers, and electricity consumers. 

    During an economic crisis of this scale, as pointed out by Keynes and other economists, governments must engage in counter-cyclical spending to help sustain aggregate demand when the private sector withdraws. Instead, following the IMF’s recommendation, the Wickremesinghe-Rajapaksa government has decided to freeze state sector projects as part of the pro-cyclical fiscal consolidation. This has further eroded the incomes of day wage laborers and those involved in seasonal livelihoods, who often depend on construction work. As a result, a UN report recently noted that incomes of unskilled labor had declined by roughly 50 percent.3 The increase in unemployment is occurring at a time when food prices alone have nearly doubled and even tripled in the case of some essential items. Wages relative to the increased cost of living have not changed, and in fact, real wages have fallen. Even nominal incomes are declining. Malnutrition, resulting in wasting and stunting among children, threatens an entire generation.

    Although inflation calculated year-on-year appears to be receding, the one-time price hikes that occurred because of the shock policies of devaluation and rising prices of commodities in the global markets last year continue to be a grueling burden. While the entire population has access to electricity, working people now fear being disconnected from the electricity grid because of the tremendous increase in prices; current measures are forcing households to ration or restrict the most basic aspects of their consumption. The government has also quadrupled the price of kerosene, with a severe impact on food production. Farmers have withdrawn from cultivating their fields, and fishers are increasingly unable to go out to sea. The price hikes have compounded the crisis of Sri Lanka’s food system that began when the previous government led by Gotabaya Rajapaksa banned chemical fertilizers overnight in April 2021. 

    Finally, the IMF’s recommendations to hike interest rates and devalue the rupee have also legitimized the Central Bank’s policy rate increase from 6 percent to 15.5 percent and the depreciation of the rupee from Rs. 200 to Rs. 360 to a dollar. The government is supposedly maintaining high interest rates to address skyrocketing inflation, even though inflation is largely the effect of import-induced price hikes sparked by the devaluation of the rupee and rising prices in global commodity markets.

    In the absence of relief, many people have been forced to pawn assets such as family heirlooms at market rates of 24 to 30 percent. Working people are in danger of losing their emergency liquid assets. Small and medium enterprises have experienced extraordinary difficulty and even collapsed because borrowing rates are too high, while consumer demand is simultaneously contracting. All these effects add up to what is best described as an IMF trap.

    The unraveling order

    Unlike past IMF agreements, Sri Lanka has effectively zero bargaining power in the current negotiations, a result of the premature decision to default in April 2022. Gotabaya Rajapaksa’s government relied on foreign currency swap lines while insisting an economic revival was right around the corner. The wasted years in the aftermath of the Covid-19 pandemic meant that Sri Lanka’s foreign exchange reserves quickly disappeared. Parliamentary opposition and prominent think tanks singularly focused on demanding an IMF agreement, believing it was the silver bullet to solve the crisis, even as they carefully avoided calling for prioritizing imports, given their commitment to the free trade regime. Eventually, they began a campaign calling for an early default, believing it would lock Sri Lanka into an IMF agreement along with rapid restructuring of its debt. The government then declared a default in April, the first in the country’s history, even when the much larger USD 1 billion in international sovereign bond payments was due months later in July. Sri Lanka is now at the mercy of its creditors, and the IMF claims an agreement is predicated on a satisfactory debt restructuring package.

    But the reality is that even in the absence of an IMF agreement, many of the recommendations in the staff level agreement have already been implemented—to disastrous effect. The IMF policy package is being used by the Wickremesinghe government to legitimize shock policies that harm the lives of working people. In addition, one of the two official conditions of an IMF agreement include targeting a primary surplus, which is the exact opposite of what Sri Lanka needs to overcome the economic depression.      

    Meanwhile, the details of further conditions imposed by the IMF for the staff level agreement have not been made public. The government, desperate to prove itself as an exemplary debtor before the IMF, claims to have implemented all the proposed recommendations, even as the IMF plays hard to get, having already missed several expected deadlines to sign the agreement. But its rhetoric deflects from a focus on the ways in which the crisis has insinuated itself into every aspect of people’s lives, including those who are forced to give up on sending their children to school, and who have yet to see any tangible relief. 

    Will the IMF face any pressure to reverse the measures that have turned the crisis into a slow-moving social, economic, and potentially even political disaster? Amidst threats of financial contagion for the global South, Sri Lanka could be the forerunner of a wave of defaults with unpredictable consequences. But two factors distinguish the current crisis from its previous IMF bailouts. First, there is no clear, global coordinated package to bailout Sri Lanka. Second, domestic political factors—including a government ruling without parliamentary elections amidst massive instability and popular discontent—will likely make the continued implementation of the current IMF policies unfeasible.

    Unlike during earlier debt crises, there is growing division between major global powers, which in the past sought to address debt resolution, albeit in their own interests. The failure of the G20 to come up with a solution at its forum of Finance Ministers held in India in February this year is a clear example of this. The cycle of global financialization appears to have reached its limits, with countries like Sri Lanka bearing the costs. A recent UNDP Briefing highlighted that fifty-two developing countries are suffering from severe debt problems.4 Several scholars are warning against the dangers of debt overhang and the need for a different architecture of development finance, advocating for a new growth path linked to debt adjustment for countries at risk of a debt crisis.5

    Some countries have obtained debt relief under specialized initiatives over the past several decades, depending on their status as low-income. This includes those part of the Heavily-Indebted Poor Countries initiative created during the late 1990s. But many more middle-income countries, or emerging markets, have been drawn into the financial vortex, a trend which became clearer during the East Asian financial crisis of 1997–1998. Prior to the current crisis, Sri Lanka had been upgraded to middle-income country status. The government’s current appeal to reassess the country’s income-status is narrowly focused on unlocking provisions afforded to low-income countries, such as concessionary rates or debt suspension provisions. It precludes discussion of what a low-income status means for the overall economy and its people, in terms of incomes, food security, and social welfare. 

    What next?

    Once a market success story, Sri Lanka is now under immense strain. Creditors are likely to attempt to extract their pound of flesh from the country, evident by the growing presence of vulture funds trying to buy collapsing debt. In addition, threats of legal action are ever-present. For example, the Hamilton Reserve Bank, which holds more than USD 250 million of Sri Lanka’s sovereign bonds, has initiated legal action, anticipating a messy, drawn-out process. It echoes creditor hold-outs for bailout agreements in other countries, including the most infamous example of Argentina. 

    Sri Lanka’s economic establishment nevertheless proclaimed a path to quick debt restructuring and a recovery through further integration with global markets and a return to commercial borrowing in the international capital markets—the very strategy that led to the crisis in the first place. Insensitive to the tremendous suffering experienced by the working people with the implementation of the IMF policy package, Sri Lanka’s elites believe in the prospect of an eventual return to the status quo after a period of severe wage repression and dispossession. Greece after its lost decade appears to be the model. 

    Compared to its sixteen previous IMF agreements, Sri Lanka’s adjustment this time around will cause an entirely different scale of suffering. The country is now at the whims of its creditors, while the elites counsel “bitter medicine” to people who are nearing an economic cliff. After a contraction during 2022 on the order of a tenth of its GDP, the economy could shrink on a similar scale in 2023. This so-called solution will have dire political consequences. 

    There is now a growing recognition that the battle over debt reflects distributional issues in a world characterized by dramatic inequality. Imposing large haircuts on debt owed to international creditors and even the possibility of debt cancellation are part of a range of alternatives.6 The Sri Lankan disaster reveals that the ailing global economic system and its prescribed solutions are itself the problem. The question is whether Sri Lanka’s working people, through a powerful refusal to bear these conditions, will help the world envision a new path of development.

  6. Debt and Power in Pakistan

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    This is the ninth edition of The Polycrisis newsletter, written by Kate Mackenzie and Tim Sahay. Subscribe here to get it in your inbox.

    In the torrent of criticism of the IMF and World Bank for their role in deepening Pakistan’s economic troubles (there is plenty of blame owed to them) the role of Pakistan’s own ruling class often gets pushed to the background. What you may not have heard about Pakistan—notorious for having received 23 IMF bailouts, for being a nuclear-armed state with terrorist groups, for suffering climate catastrophe of biblical proportions—is that the nation of 220 million people is being screwed by its domestic elites.

    IMF Managing Director Kristalina Georgieva got it right this past weekend at the Munich Security Conference when she argued for reforming domestic tax collection. “It shouldn’t be that the wealthy benefit from subsidies. It should be the poor,” Georgieva told a German broadcaster.

    The recent floods which devastated one-third of the country are an emergency of unprecedented scale, and Pakistani diplomats have been shrewd in using the crisis to press for an urgently needed global “Loss and Damage” fund. What the floods must not become is more cover for the country’s ruling elites to defer domestic reform.

    Earlier this month, Prime Minister Shehbaz Sharif complained that the IMF was giving his country a “tough time” over accessing funding, in the midst of an “unimaginable” economic crisis. Former PM Imran Khan, recovering from a failed assassination attempt, is preparing for a dramatic election season ripe with IMF-bashing. But domestically, none of these warring factions has proposed reforming the regressive tax code, which is riddled with exemptions for powerful military generals, judges, and landowners.

    During periods of crisis, the parliament frequently resorts to raising sales and fuel taxes, and levies on less politically powerful sectors, increasing cost-of-living burdens on consumers and rural peasants while driving more ordinary economic activity into the sprawling black market.
    On February 14th, the federal tax board raised the goods and services tax from 17 to 18 percent, following recent increases to petroleum tax, in a move that would deepen Pakistan’s existing revenue woes. Pakistan’s federal income tax ordinance “contains 118 pages of exemptions and low rates of taxes granted to the rich and powerful,” writes Huzaima Bukhari, an attorney and tax expert, while “those who can hardly afford to eke out a decent human living are expected to contribute to the treasury.”

    For the coming year, Pakistan’s government estimates tax revenue of PKR 5 trillion. With interest rates rising another 300 basis points, the new estimate of debt servicing costs has soared to PKR 5.2 trillion. In other words, Pakistan’s entire annual revenue can no longer service payments on its debt. Meanwhile, central bank reserves have dipped precipitously in the last year. At present they are not enough to cover the cost of three weeks of imports, further hammering industrial supply chains and consumers. 

    Researchers at the World Resources Institute tallied the carnage of last August: “Torrential rains and flooding impacted 33 million people and caused more than $40 billion in economic damages. The catastrophic flooding left 1,700 people dead, 2 million homes destroyed and killed over 900,000 livestock… The country is now experiencing mass displacement, food insecurity, loss of livelihoods and an increased risk of waterborne disease, drowning and malnutrition.”

    Under these strained conditions, Pakistan’s legislature is now negotiating a $6.5 billion bailout package with the IMF. The nation has gone to the IMF more than any other country, including Argentina. But this time—in the wake of the floods, and recent terrorist attack in Peshawar reviving geopolitical fears of Pakistan as a “too nuclear to fail” state—the crisis has a new urgency. 

    Soldiering on?

    Given dismal tax revenues, how is Pakistan’s economy functioning? 

    The EU’s geo-economic decision to include Pakistan in its free-trade zone has helped. It is Europe, and not China, that is the largest importer of Pakistani export goods. And sales, dominated by textiles, have soared since 2014, when the EU lowered import duties to zero. But that GSP status is up for renewal in 2023, conditional on labor, environmental, and good governance standards.

    Meanwhile, the ongoing oil boom in the Gulf means 9 percent of Pakistan’s GDP comes in the form of remittances from millions of its citizens working there. Dollar infusions from Saudi Arabia are also a crucial lifeline. The Kingdom has stepped in with multi-billion dollar credit lines, sent dollars-for-military-aid, and requested nuclear know-how as they seek to deter Iran.

    But these are temporary measures—as were, after all, each of the IMF’s successive rescue packages.

    In a 2012 LSE paper, former IMF economists Ehtisham Ahmed and Azeali Mohammed explain Pakistan’s twinned domestic inertia and inconsistent relationship with official external financing. They see the “stop-go” of official debt, particularly from the US, as delaying the day when Pakistani rulers would be held accountable for building domestic state capacity. 

    “Exceptionally favorable conditionality and flexibility in giving waivers, on not meeting even soft conditionality standards, has led successive Pakistani governments to treat lightly the fundamental issue of domestic resource mobilization,” they write. This extended the rule of “weak civilian governments vying for popularity, and military governments without political support seeking legitimacy.”

    Already by the 1980s, Pakistan had broken the “golden rule” of fiscal prudence, and began borrowing to fund current spending. Nearly every subsequent government deferred the need to expand the tax base and close loopholes.

    Pakistan made and abandoned attempts at reforms to raise tax revenue throughout this period, including in the mid-1980s, the late 1990s and mid-2000s. Each effort foundered when geopolitical events led to a surge in US support and cheap dollars. The IMF’s own Independent Evaluation Office in 2002 pointed out that the country was almost continuously in Fund programs between 1988 and 2000,  with all but one of the seven programs derailed by “substantial policy slippages”. Despite IMF efforts,  tax revenue actually fell in that period to 12.1 percent of GDP, from 13.5 percent. 
    Ultimately, Pakistani elites’ resistance to broadening the country’s tax base point to the primacy of geoeconomics in determining the country’s fortunes. To the US, Pakistan is above all a military outpost—which can always be propped up with accommodative lending. That has pushed the IMF to play a role that IMF economists themselves say is toxic for the country’s ambitions to be a modern, tax-collecting state.

    What revenue Pakistan does collect is not always effectively channeled into urgent investment. (See former Deputy Governor of the State Bank of Pakistan Murtaza Syed’s thread on the dynamics: 5–8 percent fiscal deficits in the public sector; low savings in the private sector.)

    Power and power

    The country’s energy infrastructure illustrates this. Ahmed and Mohammed wrote in 2012 that under-investment in energy had led to planned power cuts which particularly affected the industrial and export sectors. Today the country’s power generation capacity well exceeds the demand on it, but a quarter of the population still has no electricity at all, mostly because the grid doesn’t reach rural areas. 

    Burned by Europeans outbidding them for LNG shipments last year, the country is now declaring it will increase coal-fired power generation four-fold, running on domestic fuel that doesn’t require precious hard currency. It was not “ immediately clear” how the coal plants would be financed, Reuters noted, when even China and Japan are backing away from such projects. Nor is it clear how building more of the centralized over-indebted coal power would improve an energy system already hampered by inadequate transmission infrastructure. 

    The World Bank, hardly a champion of climate action, said in 2020 that even Pakistan’s locally fuelled coal power was uneconomic due to falling costs of renewables like wind and solar, which only supply about 2 percent of Pakistan’s power. Tax breaks on solar and wind equipment were reversed early last year in a dash to unlock another tranche of IMF finance. Improving a country’s energy system requires the patient policymaking that neither the government of the day nor international financial institutions have brought. 

    The available solutions to the crises that Pakistan faces raise suspicions domestically and internationally: While the IMF worries that bailouts will pass through directly to Pakistan’s elites, the US worries that any debt haircuts it accepts will only furnish repayments to Pakistan’s Chinese creditors. 
    As finance ministers gather this week in India, the G20 leader is putting more pressure on China to take haircuts on distressed debt. But with China continuing to call for multilateral lenders to take losses in the restructuring—an unreasonable and perhaps deliberately obstinate request, as Brad Setser has argued—Pakistan’s nest of international lenders looks as intransigent as its brazenly elite-captured domestic economy.

  7. Crisis Response

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    At the dawn of the newly implemented Eurozone, Lorenzo Bini Smaghi and Daniel Gros argued that three broad issues might present problems for Europe’s Economic and Monetary Union (EMU). Bini Smaghi, then Director for International Affairs at the Italian Treasury, and Gros, then Deputy Director and Senior Research Fellow at the Brussels-based Centre for European Policy Studies and Head of its Economic Policy Programme, wrote and published their concerns in their 2000 book, Open Issues in European Central Banking

    They argued first that there was no clear allocation of monetary tasks between member states’ National Central Banks (NCBs) and the supranational European Central Bank (ECB). The authors noted that this presented uncertainty for outcomes if central leadership of the ECB objected to NCB decision-making, during either routine business or extraordinary circumstances. It also revealed the potential for disagreement between central bank leadership of different member states to hinder nationally focused monetary policies. Second, they argued, EMU law was unclear regarding the prioritization of monetary and financial concerns—and consequently the importance of anti-inflationary policies and exchange rate targeting compared to the resolution of financial crises. The authors also identified a tension between independence and accountability. Would NCBs be held equally accountable for undershooting inflation targets as they might if they failed to contain those targets below mandated levels? Finally, Bini Smaghi and Gros acknowledged the potential tension between the goals of NCBs and the ECB. If NCBs took steps to resolve banking crises that might induce inflation, or raise fears of the specter of inflation, would the ECB be responsible for overriding NCB authority? And, in the case of national or supranational crises, should the NCBs or ECB act as a lender of last resort?

    Despite this caution, Bini Smaghi and Gros remained optimistic that the beginning of Europe’s EMU was an opportunity for greater financial and monetary cooperation within the region, and for development across the Eurozone. But two recent crises in the Eurozone have confronted Bini Smaghi and Gros’s predicted challenges—and resulted in dramatically different responses. In 2008, the ECB initially delegated crisis response to the NCBs, but it then overstepped this mandate. As the Eurozone crisis gradually took hold in peripheral members of the EMU, the ECB—citing fears of inflation—intervened to limit NCBs’ abilities to engage extraordinary measures to rescue domestic banks.1 By contrast, in 2020, the ECB enabled domestic governments and NCBs to respond to the novel challenges of the Covid-19 pandemic through a panoply of measures to increase governments’ spending potential and minimize the cost of government borrowing through different monetary policy measures.

    These differing approaches had significant consequences. In 2008, falling asset prices linked with the subprime mortgage backed security market precipitated the failure of major investment banks and internationally connected banks in the US and Europe. Likewise, in 2020, falling stock and government bond prices threatened to rock global financial markets in the absence of major interventions. In both cases, government spending increased to meet the economic challenges of the unfolding crises—both to bolster and bailout banks and large firms, but also support households with unemployment insurance as large recessions unfolded. However, the financial panics early in 2020 did not yield fiscal crises of the sort that occurred in Europe in the aftermath of 2008 and 2009. Thanks to large scale monetary policy, unprecedented willingness by governments to spend, and global agreements to suspend debt limits for internal and external fiscal borrowing, the 2020 crisis did not precipitate major fiscal crises in Europe, as its 2008 analogue had. Its management thus holds lessons not only for future crisis recovery, but for resolving the structural tensions in the EMU which Bini Smaghi and Gros identified.

    2008: Causes and consequences of the global financial crisis

    Europe’s exposure to 2008’s Global Financial Crisis (GFC) came from two directions: the Transatlantic asset bubble for subprime mortgage backed securities, which appeared to be incapable of falling in value, and the proliferation of shadow banking and the use of repurchase agreements for banks’ short term liquidity operations. Just as Bini Smaghi and Gros had suggested, divisions emerged between banks in Europe’s larger and smaller economies after the creation of the Eurozone. While banks in Europe’s core economies tended to acquire more securities relative to total assets and to engage in more international financial activity, banks in Europe’s periphery tended both to lend more as a share of total assets, and to engage in more domestic activity. Banks in Europe’s core economies, particularly Germany, the Netherlands, and France, were likely to purchase subprime mortgage backed securities, while banks in more peripheral economies, like Ireland, Spain, Italy, and Greece, were unlikely to do so. When the market for subprime mortgage backed securities collapsed in 2007 and 2008, banks that had accumulated large holdings of assets were at greater risk of failure than those that had not. 

    However, banks in the Eurozone’s periphery that were less exposed to subprime mortgage losses were still indirectly linked to these tensions. Many large investment banks in the US and Europe had acquired subprime mortgage backed securities, putting them at risk of failure when those assets fell in value. Those large financial intermediaries had become lynchpins of the global financial system through their funding of repurchase agreements (also called repos). Repos are short-term liquidity arrangements under which a borrower like a bank sells an asset to a counterparty; the borrower is then contracted to repurchase that asset from the counterparty as soon in the future as twelve or twenty-four hours later. Large investment banks like Bear Stearns and Lehman Brothers helped fund global repo markets, which had grown from 2000 through 2007 in their importance for banks in the US and Europe.2 The failure of Lehman Brothers in particular created funding problems for hundreds if not thousands of banks that indirectly depended on it for shadow banking liquidity services, and the global financial system appeared to be poised on the brink of collapse. 

    In the European Union, the European Commission and the ECB delegated crisis responses to the national level.3 Governments and NCBs would conduct the measures necessary to resolve the financial and economic fallout from the rapidly developing GFC. Most of these governments worked alongside their NCBs to bail out domestic financial institutions. However, European banks that had branches in the US and had purchased subprime mortgage backed assets, qualified for expansive liquidity services from the Federal Reserve, which had promised to purchase now toxic assets to expedite banks’ return to lending.4 The Federal Reserve’s commitment decreased the fiscal burden for governments of core economies, while governments of more peripheral economies bore a larger share of rehabilitating their domestic banks, and issued more sovereign debt. 

    Figure 1: Long-Term Sovereign Bond Rates, 2000–2010
    Source: OECD Statistics, Financial Statistics, Monthly Long-Term Interest Rates

    As government debt to GDP levels rose within the Eurozone, private creditors holding European sovereign debt sold off bonds issued by governments of peripheral economies, including Ireland, Greece, Portugal, and, later, Spain and Italy, while continuing to purchase sovereign debt issued by core economies like France and Germany. Figure 1 shows the early phases of this change: bond yields—the relative return on bonds, or the relative cost for governments of funding that debt—grew for debt issued by peripheral economies relative to core economies. Credit rating agencies responded to these growing spreads between peripheral economies’ and core economies’ government bonds by downgrading peripheral economies’ sovereign bonds, which further increased those governments’ costs of responding to ongoing crises. 

    Monetary policy rules in the Eurosystem exacerbated the costs of these downgrades. As credit ratings on peripheral economies’ sovereign debt fell, those countries’ NCBs paid more to use those bonds as collateral for routine monetary operations. In Greece’s case, credit ratings for Greek sovereign debt fell so low that the Bank of Greece was prohibited from using those bonds as collateral for monetary operations. Downgrades of peripheral economies’ sovereign bonds further depressed private demand for those bonds, which triggered more bond sales, further increasing the cost for those economies to fund their fiscal expenditure, while increasing the costs for their NCBs to support domestic banks. This feedback loop is what is referred to as the Eurozone Crisis’s “Doom Loop.” 

    When NCBs in peripheral economies ran out of collateral that they could use for monetary policy within the Eurosystem, they attempted to deploy Emergency Liquidity Assistance (ELA) for domestic banks. ELA allows NCBs to use collateral outside of officially approved assets to access funds to lend to distressed banks. However, NCBs must submit their plans to the ECB at least two business days in advance; if two out of three or more members of the ECB’s Governing Board vote against the plan, they may prohibit the NCB from deploying those measures. When the Bank of Ireland attempted to use ELA in 2010 to support Irish banks, Jean-Claude Trichet, then head of the ECB, threatened to veto those measures if the Bank of Ireland and the Irish government did not commit to funding the rescue and paying the ECB back for any incidental support.5 When banks in Cyprus and Greece petitioned their NCBs for ELA support, the ECB again made the deployment of such measures contingent on the respective NCBs’ and governments’ commitments to paying the ECB back for any ancillary support.6

    By 2012, financial instability in peripheral Eurozone economies threatened to spill over into markets for core economies’ sovereign bonds.7 By that point, then head of the ECB Mario Draghi committed in a speech to doing “whatever it takes” to mend the fraying Eurozone. The ECB soon approved measures to backstop sovereign bonds across the Eurozone in the Sovereign Bond Purchasing Programme (SBPP). This program authorized member NCBs in the Eurozone to buy proportional shares of sovereign bonds issued by peripheral Eurozone members with an adequate credit rating, which excluded Greece at the time, in order to stabilize that bond market. Qualifying members’ bond yields began to converge soon after. However, this policy mandated that participating economies commit to austerity and other restructuring measures as a quid pro quo for this liquidity support. Figure 2 shows the effects of these changes on peripheral bond yields during the worst years of the Eurozone Crisis. As peripheral members of the Eurozone came to the brink of default on their sovereign debt, yields spiked higher. When the ECB initiated relief measures, those spreads decreased again. Greece’s exclusion from the SBPP prolonged its heightened cost of spending relative to other European economies. While sovereign bond rates for peripheral Eurozone economies worst affected by the Eurozone crisis gradually decreased, these changes came at the cost of diminished fiscal autonomy, double-digit unemployment rates, and general economic malaise.

    Figure 2: Long-Term Sovereign Bond Rates, 2008–2018
    Source: OECD Statistics, Financial Statistics, Monthly Long-Term Interest Rates

    2020 and beyond: the Covid-19 pandemic

    In 2020, the precipitating event for financial uncertainty in Europe and elsewhere came from growing alarm about the increasingly apparent physical and economic toll of the pandemic. The early epicenter of the spread of Covid-19 in Europe was Italy; as the Italian government responded to mounting Coronavirus cases by imposing shutdowns and increasing payments to firms, banks, and households, its government debt increased relative to GDP. Bond holders responded to these rising debt levels by selling Italian government bonds, triggering an initial increase in Italian sovereign bond rates, and prompting Christine Lagarde, head of the ECB to announce on March 12, 2020 that the ECB was not planning to target spreads. Lagarde’s announcement spurred another large sell-off of Italian sovereign bonds, further increasing the rate on Italian sovereign bonds and widening the spread between Italian government bond yields and German government bond yields. Lagarde reversed course within a day, and echoed Draghi, saying that the ECB would do “whatever it takes” to preserve the Eurozone’s economy, including targeting bond spreads.

    The ECB and the European Commission worked in tandem to support government borrowing from that point onward: the European Commission suspended required limits on deficit and debt ratios to GDP, and the ECB initiated the Pandemic Emergency Purchase Programme (PEPP), which allowed NCBs across the Eurosystem to purchase all manner of bonds, with a waiver of existing restrictions on their purchases of Greek sovereign bonds, to facilitate money creation, financial activity, and government expenditure. Bond spreads between core and peripheral Eurozone members converged again, and bond yields on peripheral European governments’ debt fell below zero. These measures provide a stark contrast with the relative unwillingness of the ECB to enable NCBs to act as lenders of last resort in the aftermath of the GFC of 2008.  

    Figure 3: Long-Term Sovereign Bond Rates, 2019–2022
    Source: OECD Statistics, Financial Statistics, Monthly Long-Term Interest Rates

    Figure 3 shows the trajectory of sovereign bond interest rates and extraordinary liquidity programs from 2020 through 2022. Early uncertainty about economic consequences of the crisis are reflected in a small spike in rates for economies like Greece, Italy, Portugal, and Spain. By mid-2020, sovereign bond rates throughout the Eurozone decreased thanks to NCBs making consistent purchases of sovereign debt because of PEPP. By late 2021, as governments, central banks, and pundits discussed global recovery and rising inflation rates, sovereign bond rates across the Eurozone began to diverge again. By early 2022, pandemic-related spending and liquidity programs had gradually expired, likely increasing private investors’ uncertainty about bond risk. While sovereign bond rates for Italy and Greece were still less than 5 percent by September 2022, below the heights those rates reached in 2011 and 2012, the fate of these rates is an open question, especially as rates have increased for core members as well. 

    A discussion of two crises

    A divide emerges between how the ECB hindered or facilitated fiscal responses to these two international crises, despite the Federal Reserve’s willingness in both periods to prevent liquidity crises from worsening. In 2008, the ECB resisted implementing a comprehensive European strategy, to deter volatility in credit markets for European sovereign debt. Its limited response to the GFC, compared to the Federal Reserve, increased the national burden for NCBs and domestic governments. However, because banks in core economies with greater exposure to the subprime mortgage bubble retained access to liquidity programs initiated by the Federal Reserve, governments of core economies bore a smaller relative burden in rescuing their domestic financial sectors than did governments in peripheral Eurozone economies. When the ECB relented in 2014 and increased its willingness to facilitate government spending by reducing volatility in markets for peripheral economies’ sovereign debt, it tied these measures with requirements that those economies commit to austerity, nullifying the expansionary potential of these measures. 

    By contrast, during the onset of the pandemic, the ECB used monetary policy to directly facilitate sovereign debt issuance, and by extension, government spending. Though European law officially prohibited NCBs from directly purchasing government debt, and despite a legal challenge from the Bundesbank, the central bank of Germany, the European Court of Justice ruled that the ECB was empowered to implement such programs. Moreover, by explicitly waiving the Stability and Growth Pact, which mandates that European governments not exceed maximum deficit and debt to GDP limits, the European Commission provided policy ballast to empower governments to spend as much as necessary to address the novel challenges of the global pandemic, including wide-ranging fiscal policies meant to support households at risk of unemployment.

    The ECB’s divergence from past practice during the early months and years of the pandemic deserves attention for multiple reasons. First, the ECB’s ability to shift the trajectory of Europe’s economic experience of the pandemic is a reminder of the power of monetary policy to prevent panics in financial markets from hollowing out governments’ abilities to spend expansively to address unprecedented economic challenges. As these liquidity programs have expired, private investors’ mounting uncertainty has had material consequences for the cost of government spending in more peripheral Eurozone economies. If rising sovereign bond rates inhibit spending that can sustain economic recoveries, or address novel physical and economic challenges like climate change, then monetary authorities’ decisions about when to backstop sovereign debt markets may facilitate or inhibit such changes. The ECB’s ability to promote or inhibit fiscal spending is another reminder of the ambiguity of central bank independence. If the European Commission opposes government spending, then an independent ECB may encourage spending despite political opposition. By contrast, if governments believe that spending is desirable, ECB opposition to inflation may curb that potential, with no external check. Finally, the ECB’s ability to change course—to become either more dovish or more hawkish—highlights the importance of political commitments. The ECB demonstrated a commitment to government spending in a moment of global crisis in 2020; whether it believes inflation risks in 2022 and beyond represent a similar crisis may trigger policies that reverse those gains. 

    Despite rising inflation and successful rate hikes since the beginning of 2022, the ECB appears to remain committed to targeting bond spreads in the Eurozone. In June 2022, the Eurosystem’s leadership debated how to implement the Transmission Protection Instrument, which would authorize NCBs to purchase sovereign debt again, if spreads were at risk of diverging. Whether it implements this policy or not, the Eurosystem appears more structurally open to supporting members’ ability to respond to crises with both monetary and fiscal policy, and to preventing such calamitous divides in the future. 

    Moreover, the contrast between the ECB’s response to the crises of 2008 and 2020 holds lessons for managing the inherent structural challenges of the Eurozone identified by Bini Smaghi and Gros. In 2008, the ECB’s decisions to delegate policy responses to the national level of the Eurozone reflected its commitment to prioritizing monetary stability over financial stability. The ECB was willing to sacrifice member states’ economic potential until those costs threatened to harm investors’ confidence in debt issued by core economies like Germany and France. 

    However, in 2020, the ECB appeared to demonstrate a broader commitment to EMU-wide stability as well as to enabling domestic autonomy in monetary and fiscal policy. The ECB’s decision to promote government spending by deliberately backstopping markets for European government bonds proved that the ECB was capable of leveling the field between peripheral and core members. Its apparent commitment to finding ways to minimize bond spreads between government debt issued by the Eurozone’s core and periphery in order to maintain EMU members’ fiscal space even after inflation rates have risen globally provides a source of optimism about whether these tendencies will continue outside of global crises. Whether the ECB persists in raising rates, it has shown a willingness to grant members’ governments and NCBs the agency to respond to crises, whatever the worries of private investors may be. 

    This essay is derived from the author’s forthcoming paper “Institutional Constraints, Liquidity Provision, and Endogenous Money in the Eurozone Core and Periphery Before and After Crises” in PSL Quarterly Review.

  8. Securitizing the Transition

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    In the eyes of the IMF, a G20 panel, and, lately, the US Treasury Secretary, the time has come for multilateral development banks to adapt their development mandates to the logic of derisking. This tactic—lauded as a solution for “mobilizing” the trillions necessary to achieve the green transition—demands that public entities shift private investors’ risks onto their own balance sheets, incentivizing investment to meet the world’s infrastructure needs.

    Although development banks have floated serious plans to reorient themselves toward catalyzing private investment since the “billions to trillions” hype in 2016, such efforts never took off. The World Bank’s recently leaked “Evolution Roadmap” is its latest attempt to kickstart derisking at a global scale. 

    But the roadmap’s emphasis on mobilizing private finance through derisking obscures one proposal that on the surface appears to run the other direction. Securitization allows public entities and development banks to offload their assets to the private sector, thereby transferring risk away from themselves and freeing up their balance sheets for more immediate lending. To be sure, securitization still fits snugly within economist Daniela Gabor’s Wall Street Consensus, in which governments meet development goals by turning public services into investment opportunities for private finance.1 But while derisking calls for the public sector to shoulder additional risks, securitization calls for shrugging them off. 

    How would securitizing the World Bank’s portfolio work, and how does this tactic relate to  the larger derisking turn in development finance? Is securitization a preferred alternative to derisking, or does it align with its broader logic?

    Parts of the development community have advocated for risk transfer through securitization as both countercyclical and prudent: securitization supposedly frees up multilateral development banks’ balance sheets for more green investment, especially during times of market stress and higher emerging market borrowing costs. The best available precedent is the African Development Bank’s (AfDB) 2018 Room2Run initiative, through which it securitized $1 billion of its private sector project loans. 

    On closer examination, however, securitization’s promise to free up public balance sheets parallels the promise of privatization—and it threatens to produce the same failures. The securitization of development bank assets is procyclical insofar as it chains development finance to volatile private investment trends, and as such it may ultimately reduce development banks’ fiscal space for investment. While securitization may free up balance sheets in the short term, in the long run this is yet another financial “innovation” that will put private investors in the drivers’ seat of the green transition―likely at considerable cost to everyone else.

    Securitization or privatization?

    Conventional asset-backed securitization for green infrastructure resembles mortgage-backed securitization. The World Bank or any other entity could pool and collateralize its assets’ revenue streams to borrow on cheaper terms from an institutional investor.2 Given the existing framework for securities regulation and risk weighting, proponents of development bank asset securitization believe that “capital relief” or “increased lending headroom” will result, given that securities they offer up will be cheaper and less risky for investors to purchase. The amount of risk that a development bank can offload will determine how much more investment it can undertake—a mundane argument, consistent with the laws of accounting. 

    This line of reasoning, however, echoes the World Bank’s Washington Consensus promise that freeing up public balance sheets through the privatization of state assets would improve a country’s investment climate. Securitization and privatization both press public entities to surrender control over assets, or at least their revenue streams.

    Privatization, for its part, has not exactly succeeded. Water privatization drives in Bolivia, Nigeria, and elsewhere across the global South have been failures. The complete privatization of British utilities is complicit in the country’s cost-of-living crisis. And the privatization of Puerto Rico’s energy grid has not helped the territory’s communities weather increasingly severe climate disasters. Writing off these letdowns as examples of poor implementation only serves to paper over privatization’s glaring conceptual flaws.

    Crucially, investors don’t want to buy just anything. Given a pool of public assets to choose from―hospitals, utilities, transit―private investors will cherrypick those with steady revenue streams from wealthier and more concentrated groups of citizens. Absent strict regulation, infrastructure privatization usually also permits an asset’s new owners to raise prices, lay off staff, and diminish service quality―all to maximize revenues and cut costs. Asset manager Macquarie’s ownership of an English water utility, for example, left customers paying higher prices while letting raw sewage leak into the country’s rivers, while the proposed deregulation of India’s electricity distribution sector has sparked protests over fears that it will degrade rural electricity provision and harm electricity sector workers. While the private sector profits from serving the privileged, the public sector loses money serving everyone else. This segregation is by design. 

    While securitization could leave a development bank’s assets under nominally public control, it ultimately mirrors privatization. If development banks must depend on the sale of their securitized assets for new financing but investors will buy only those that offer the least risk, then banks face a perverse incentive to offload their best assets. Private investors’ sustained retreat from higher-risk global South economies suggests that any successful securitization will be quite limited in both scale and revenue generated.

    Regardless, public-serving infrastructure remains an illiquid asset with unpredictable future revenues. A rush to offload these assets will quickly depress their sale prices, subsidizing private buyers and leaving governments and development banks short of the capital relief they’re seeking.


    Even if development banks are compensated fairly for their assets, Australia’s “asset recycling” program demonstrates how they could end up saddled with greater liabilities than they started with.

    Asset recycling was an infrastructure privatization program established in 2014 with the same explicit goal as infrastructure securitization—to free up “asset rich, cash poor” public balance sheets for new investment. By the time it was shut down in 2016, however, it seems to have done the opposite. Selling future revenue flows to pare down existing liabilities should have left Australian states’ net debts—and therefore their ability to raise new investment—unchanged at best. In reality, because “income-generating assets were sold to finance new investments that did not generate income,” in the words of Australian economist John Quiggin, asset recycling increased Australian states’ debts and decreased public sector net worth in the eyes of private creditors.

    Because many of the new investments were public-private partnerships, Quiggin judged that financing them usually involves “hidden government borrowing or guarantees.” Indeed, Australia’s federal government privatized its Federal Health Commission to promise a two-year, 15 percent subsidy to every new infrastructure project built with money from a state asset sale.3

    Green infrastructure securitization could see similar results. Many of the investments most needed to combat climate change―dense housing, mass transit, mangrove restoration―are public goods that don’t easily generate the kind of income that attracts private investors. That goes especially for emerging markets, where regulatory and currency risks can spook foreign capital. Following Quiggin’s logic, persistent asset securitization may therefore erode development banks’ balance sheets over the long term—returns-generating assets will be collateralized to finance necessary but likely unprofitable green infrastructure and restoration projects. The subsequent deterioration in these banks’ net worth won’t look good to shareholder governments and might impact their willingness to recapitalize. Development banks will be incentivized to build infrastructure that can turn a profit. This course of action would not only be massively inequitable, it would fail to meet the world’s green investment needs.


    The AfDB’s Room2Run initiative serves as a test case for the future of securitization as a development strategy. Here, $1 billion of private sector loans were “synthetically” securitized. Projects themselves stayed on AfDB’s books; all AfDB did was transfer the risks of its securitized loan portfolio to private investors, allowing it to mobilize $650 million in new lending, according to the bank. Synthetic securitization achieves a similar outcome to conventional asset-backed securitization through the purchase of credit protection, which could allow the World Bank to lend more elsewhere. 

    Room2Run highlights how securitization puts public money towards derisking private finance rather than the other way around, precisely by shielding the private sector from the highest risk assets. The AfDB held onto the lowest tranche of its security to insulate private investors from the risks of the weakest assets in the portfolio and paid a hedge fund for credit protection on the second-weakest tranche, costing around $100 million. Additionally, the AfDB secured a $100 million guarantee from the European Commission over another tranche of Room2Run. In total, Room2Run saw the AfDB retain ownership of nearly $750 million of the $1 billion in loans that it securitized. Although the AfDB was securitizing its private sector portfolio, which should have offered higher returns than its public-sector counterpart, not even these private assets were “bankable” without the AfDB’s or European Commission’s derisking measures.

    Freeing up $650 million in new lending (if the figure is accurate) is still significant. An Inter-American Development Bank working paper argues that for securitization to work, banks and governments must address the considerable information and risk appetite asymmetries between themselves and private investors. But given Room2Run’s four year preparation period and perhaps overcomplicated structure―these are bitterly tough coordination problems to solve―attempting to meaningfully scale securitization into a legitimate climate finance solution wastes precious time.

    Source: Gabor, Securitization for Sustainability (2018).


    By relying on the whims of private investors’ risk appetites, development banks are tying themselves to global financial cycles that could render their climate investment goals unachievable, while also exposing them to even greater investment risks.

    Privatization schemes falter when global financial conditions do. Emerging market governments struggle to secure a fair price for their assets when investors won’t spend on risky ventures abroad.4 Similarly, governments and development banks that securitize their infrastructure assets in emerging markets must ensure that the risk-adjusted returns match or exceed those of dollar-denominated assets to keep investors interested.5 Under today’s stormy global market conditions, “investors must be given a reason (higher returns) to invest in an EM rather than move their money into less-risky US assets,” a recent World Bank blog summarizes.  This sheer scale of derisking required to placate private investors―which will rise as risk perceptions worsen―will undoubtedly harm the health of public balance sheets.

    What’s more, financial policymakers have long known that securitization is correlated with overall markets in a potentially damaging way. “Securities financing markets fed boom-bust cycles of liquidity and leverage,” former Bank of England governor Mark Carney wrote in 2014 about the shadow banking industry that caused the 2008 global financial crisis. Similarly, as Gabor noted in 2018, “the IMF recognizes that encouraging countries to join the global supply of securities exposes them to the rhythms of the global financial cycle over which they have little control.”

    What happens when the revenue streams backing these securities become erratic or dry up? In a world of intensifying, interlocking, and sometimes unforeseen challenges, there is an increasing chance that the infrastructure assets development banks and governments turn into collateral become illiquid or insolvent. A collapse in collateral value that threatens high-leverage institutional investors involved in a securitization scheme would stop any infrastructure securitization market in its tracks.

    And yet today, Carney chairs the Glasgow Financial Alliance for Net Zero, a group of institutional investors and financial institutions allegedly committed to a swift green transition, which has praised securitization as an innovative financial structure. The IMF’s latest Global Financial Stability Report also endorses securitizing green bonds ”with the public sector providing risk reduction.” The proponents of securitization have failed to acknowledge the dangerous interplay between financial and climate risks.

    Boom or bust?

    Development banks are part and parcel of the climate crisis and policy responses to it. But those that retool themselves to mobilize private capital will end up funding infrastructure that meets private standards for investment, not public ones. Despite their seemingly opposite motives, both derisking and securitization work in tandem to guarantee private investors consistent returns backed by public funds.

    As the parallels between privatization and securitization make clear, turning public investments into worthy collateral for private investors embeds development banks into a crisis-prone, undemocratic financial system. As Anusar Farooqui and Tim Sahay put it, “a boom-bust dynamic” in green investment “would destroy the moral economy of the energy transition,” not to mention waste valuable time that the environments we want to preserve do not have.

    Reincarnated in its Evolution Roadmap, the World Bank’s push to “maximize finance for development” has ended up promoting the wholesale financialization of development itself. By letting privately held notions of risk, profit, and thrift guide the provision of global public goods, development policymakers are surrendering public control over the future of the planet. Relying on private capital to make ends meet is a Faustian bargain, threatening to transform governments and development banks into the risk-averse, profit-maximizing investors whose money they’re seeking. 

    Disclaimer: the views expressed here are the author’s personal opinions alone. They do not necessarily represent and should not be construed to represent the views of the Department of Treasury or the United States Government.

  9. The Carbon Triangle

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    China has ended zero-Covid. The resultant viral tsunami is crashing through China’s cities and countryside, causing hundreds of millions of infections and untold numbers of deaths. The reversal followed widespread protests against lockdown measures. But the protests were not the only cause—the country’s sagging economy also required attention. Outside of a few strong sectors, including EVs and renewable energy technologies, China’s economic dynamo was beginning to stutter in ways it had not in decades. 

    Whenever global demand or internal growth faltered in the recent past, China’s government would unleash pro-investment stimulus with impressive results. Vast expanses of highways, shiny airports, an enviable high-speed rail network, and especially apartments. In 2016, one estimate of planned new construction in Chinese cities could have housed 3.4 billion people. Those plans have been reined in, but what has been completed is still prodigious. Hundreds of millions of urbanizing Chinese have found shelter, and old buildings have been replaced with upgrades. 

    The scale of construction has been so prodigious, in fact, that it has far exceeded demand for housing. Tens of millions of apartments sit empty—almost as many homes as the US has constructed this century. Whole complexes of unfinished concrete shells sixteen stories tall surround most cities. Real estate, which constitutes a quarter of China’s GDP, has become a $52 trillion bubble that fundamentally rests on the foundational belief that it is too big to fail. The reality is that it has become too big to sustain, either economically or environmentally. 

    Recognizing this danger, in 2020 China implemented limits on developers’ ability to borrow. Firms that crossed the three “red lines”—liabilities-to-assets ratio of 70 percent, 1:1 net-debt-to-equity ratio, and cash greater than short-term borrowing—would be cut off from accessing more loans, an attempt to reduce the leverage of developers who had become addicted to debt-fueled growth. Evergrande, a mega developer, became the poster child of unsustainability, defaulting with over $300 billion in debt. Other developers such as KaisaFantasia, and Modern Land also failed to repay creditors in 2020 and 2021. 

    Many buyers who bought their homes in “pre-sales”—that is, paid for their houses prior to their construction—now find that those funds have been squandered, causing some to boycott mortgage payments on homes that may never be built. Freedom House’s China Dissent Monitor has tracked 272 separate acts of dissent, mostly group demonstrations, related to housing in 2022. Developer defaults had exploded past $31 billion by August of last year, and markets have priced in over $130 billion-worth.1 Most ominously, the belief that real estate is a good investment seems to be dissipating. As economist Michael Pettis noted, three years ago, a People’s Bank of China survey found the ratio of people who thought house prices were likely to rise versus decline to be 2.4 to 1. In the December 2022 PBOC survey, that figure has dropped below parity.2 The news that China’s population shrank last year once again calls into question who, precisely, is ever going to live in all this housing. 

    Despite knowing that the construction party needs to be wound down, all indications are that the government will again try to pump up the sector. Developers’ stocks have already rocketed upward, and the PBOC sounds a lonely note in trying to tamp down expectations as officials worry about China catching the global inflation that it’s avoided so far. 

    All of this is symptomatic, however, of a deeper problem facing China’s economy, a complex interaction of finance, land, and real estate that I call the carbon triangle.

    The triangle

    In the 1970s, Chinese political elites led by Deng Xiaoping emphasized that the country needed to “seek truth from facts”—a classical Chinese maxim popularized by Mao Zedong himself—rather than remain mired in ideological battles while the people starved. This clever quoting of Mao to upend Maoism helped orient politics and policies towards a few key metrics. Now it is GDP, but initially, this meant increased agricultural production. 

    China is a country of more than 1.4 billion people and has a history of famine; the disaster of the Great Leap Forward killed as many as 40 million people barely sixty years ago. Making sure that there is enough food to eat has been a principal concern of political leaders ever since and was the source of another “red line” policy—the area of cultivated land is not to be diminished. In a 1994 fiscal overhaul, the central government granted cities the power to convert land for urban use, in part as an attempt to corral blind urban development. 

    As with most systems designed to maximize particular performance indicators, this system of “limited, quantified vision” created blindspots where problems such as corruption, pollution, and falsification were allowed to accumulate. But the principal issue was over-investment in pursuit of GDP growth. Construction directly increases GDP, even if what is being constructed barely gets used. But development-incentivized local cadres faced an additional constraint—the central government alone maintained taxing authority, and finding the revenue to pay for their own salaries, let alone public goods and services, has always been difficult. This land conversion was their solution. 

    Land sales became a critical budget fixer for heavily indebted Chinese local governments, providing about 30 percent of revenue in 2021. In 2022, however, with the softer real estate market, this income stream plummeted by nearly a third. As a consequence, government deficits are breaking records—8.96 trillion yuan in 2022—just as they face some 3.65 trillion yuan in debt repayments this year. A long discussed property tax continues to face resistance from the propertied middle classes and the officials in their circles. With limitations on where they could build and facing the local land monopolist, developers bid up the prices of land leases at auctions. By then building on that land, they helped local officials both by providing revenue directly and by contributing to GDP. 

    Why build with 30 million new apartments still empty? There may not be people who want to live in them but there are people who want to buy them. Despite persistent poverty, economic growth has created a class of hundreds of millions of Chinese people with plenty of savings and not a lot of places to invest them. Capital controls limit their ability to diversify their holdings outside of the domestic market, and the Chinese stock market makes gambling in Macau look like a safe bet. But the government has repeatedly signaled that it will not let home prices collapse. 

    The carbon

    Why do I call this the carbon triangle? Because China is the world’s leading emitter of greenhouse gases, producing around 30 percent of global carbon emissions; the US, at No. 2 contributes 13.5 percent.3 Beyond direct emissions, constructing empty buildings is a significant waste of labor and of land. Land is necessary for agriculture as well as for acreage-hungry renewable energy sources like solar and wind. The vast swathes of concrete that constitute Chinese cities are also increasingly vulnerable to massive flooding episodes. Top-down efforts such as the “sponge city” campaign to adapt urban infrastructure for heavy rainfall are unlikely to prove sufficient; many are already falling by the wayside.

    China’s emissions are different from those in the US (and even more different than Europe) in shape as well as size. While transportation, electricity, and heat dominate emissions elsewhere, in China, electricity, construction, and industry are king. 

    China produces more than half the world’s steel and cement, and those two sectors alone account for about 14 percent of global CO2 emissions. Chinese steel and cement production have become more efficient over the past decade, but their emissions have skyrocketed nonetheless because production volumes have increased by so much more—a multiple of three for cement and five for steel compared with fifteen years ago. The extent of this endeavor can be simultaneously difficult to fathom for outsiders and perfectly normal to insiders.4 Consider the following section from David Sandalow and co-authors excellent Guide to Chinese Climate Policy 2022, buried in the middle of paragraph of Chapter 18: 

    Tsinghua’s Institute of Climate Change and Sustainable Development estimates that the massive demolition and construction of new buildings leads to as much as 40 to 50 Mt of steel and 220 to 260 Mt of cement every year. When taking into account the energy consumed in the construction process, this results in an additional 120 mtce5 energy consumed every year, or 5 percent of global energy consumption (emphasis added).

    Again much of this construction is not actually producing value as housing or office space. Only fugitive methane emissions and deforestation put more greenhouse gasses into the atmosphere while producing less value than the Chinese construction sector, which means that right-sizing that sector represents an immense opportunity to slash global emissions. To be clear, the ‘value’ here is not meant in monetary terms but instead in terms of services for people, as the IPCC put it, to help us live our lives well. Rhodium Group estimates the stable level of demand for construction in China at 550-750 million square meters annually, which would require another 15-37 percent decline from the level of newly started projects today. The IMF recently suggested a higher level and wider range, 750-1050 million square meters, for the steady-state. However, the upper range here is almost certainly too high. Completed construction has remained bouncing around 800 million square meters for the past decade, so a suggestion that what is needed is an increase of 200 million square meters annually given all of the existing emptiness is odd. That answer though raises another question—why focus on construction starts rather than completions, which aren’t so far off of the steady-state level? Projects that begin construction but stall out tend to use much of the gross tonnage of material involved. See all the steel and concrete husks of projects that have faltered with the more intricate work to transform those husks into livable units. But in emissions terms, those bare husks represent most of the embedded emissions in a constructed building. 

    If residential construction continued to slide to say 600 million square meters, Chinese cement production could fall from well over two billion tons annually to only 1.2 billion tons going forward. Steel could follow a similar path. A gigaton of CO2, 2 percent of annual global emissions, could disappear. 

    That right-sizing has begun. The question is, will it be allowed to continue, or will the Chinese government succeed in achieving its 5 percent GDP growth target by repowering its over-leveraged real estate market? 

    Chinese officials have long understood that the carbon triangle needed to be dismantled, but they have struggled to do so because of how deeply enmeshed it is in the country’s political and economic fortunes. If China is able to rev up the economic engine with real estate—as many Australian mining conglomerates, Chinese housing speculators, and vulture funds scooping up developers’ distressed debt are hoping—then emissions will surge. But while powerful forces are invested in that path at the moment, everyone involved understands that this debt-fueled, deficit-exploding, inequality-stretching, land-wasting concrete expansion cannot and should not continue forever. Demand signals remain weak, yet most economists predict growth at around 5 percent, which would be impossible without a return to growth in real estate construction. Xi Jinping has regularly declared that “houses are for living and not for speculation.” If this idea can move from mere slogan to reality, then China will have taken a major step towards building its own green new deal. 

  10. The EU and the IRA

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    This is the eighth edition of The Polycrisis newsletter, written by Kate Mackenzie and Tim Sahay. Subscribe here to get it in your inbox.

    At Davos last month, European Commission president Ursula von der Leyen announced Brussels’ “Green Deal Industrial Plan for the Net-Zero Age.” A response to Washington’s multibillion dollar commitment to manufacturing and energy investment, Europe’s new industrial plan will institute sweeping reforms to reduce greenhouse gas emissions. “Our economies will rely ever more on international trade as the transition speeds up to open up more markets and to access the inputs needed for industry,” she said, pointedly urging the attendees to “facilitate open and fair trade for the benefit of all.”

    Europe’s climate policies include the world’s oldest emissions trading scheme to date—now in its eighteenth year. The plan commits to net zero by 2050 across all domestic infrastructure and industries. Those impressive plans were devised in very different conditions to those of the US. While much of its Green Deal roadmap was developed during Covid lockdowns and updated after the Ukraine invasion, European policy was crafted in a world where carbon taxes and pricing on carbon markets were going to do the job domestically, while cheap green goods could be imported from elsewhere. The US, by contrast, has forged its signature climate policy in a period of protectionism and wariness towards China.

    Europe is now experiencing whiplash as it adjusts to the US’s more zero-sum vision for energy investment. If China imposes export controls on its cheaper solar panels, electrolysers, or wind turbines in retaliation to US chip controls, those backbones of EU’s climate policy would break.

    Two tracks

    Europe proposes to initially provide funding under an existing program, NextGenerationEU. It is the centerpiece of Green Deal funding, providing up to €723.8 billion in grants and loans, evenly divided. The amount compares favorably with estimates of total Inflation Reduction Act (IRA) funding (if the DOE loans are excluded), but EU countries have spent somewhere in that vicinity—about €600bn—to shield consumers from energy price rises in a single year! The total quantum of IRA funding is limitless to evade spending constraints imposed by deficit-hawks in Congress. Uncapped tax credits offered under IRA could end up providing $250bn just for solar, wind and battery manufacturing, according to estimates by Credit Suisse—eight times the official estimates. 

    The European Commission also proposed to loosen state aid rules, extending temporary reprieves made under Covid and the Ukraine war. That benefits the big member countries who can lavish funds on corporate champions. Other states will be compensated, eventually, with money from a European Sovereignty Fund. The proposals face opposition from some members, such as Netherlands and Sweden, although the FT quotes an unnamed official acknowledging that “Even the more liberal ones in the flock realize the world has changed.” Countries so far are divided on state aid and joint funding; Germany is for the state aid changes and against joint debt, for example, while Italy has the reverse stance. 

    The trans-Atlantic differences extend well beyond financing structure. The EU has historically spent its green state funds differently to the US. The bloc is now heavily dependent on China for the devices and even minerals that are essential to its relatively strong climate goals. Indeed, the Chinese solar PV industry can in part thank Germany’s Energiewende for catalyzing it into world-domination status. Meanwhile, European solar PV manufacturing has all but vanished. “I don’t mind that we put €450 billion a year into the green transition. But if it is about buying Chinese solar panels and losing our jobs, I say No,” internal markets commissioner Thierry Breton declared on French television last month.

    For decades Europeans have bemoaned US foot-dragging on climate action. When Washington finally embraced green industrial investment, rather than rejoicing, European politicians responded with complaints that their companies will be enticed to invest across the Atlantic. 

    The EU approach has avoided industrial policy in favor of retrofitting existing industries and decarbonizing infrastructure, while the IRA hands out tax credits to all comers willing to locate in the US, with extra incentives for those using domestically-sourced components. 

    For example, Spain’s most recent grant from the EU’s pandemic-era Resilience & Recovery Facility recovery fund, which will become a key part of Green Deal industrial plan support, goes towards projects such as decarbonizing buildings and the domestic energy system, as well as public mobility measures. New guidance for the mechanism mentions solar-panels manufacturing alongside subsidies for heat pumps, building retrofits, and decarbonizing industry. 

    Meanwhile, the IRA has announced a simpler proposition. By offering companies billions of dollars—largely through a system of tax credits—the law aims to jump-start investment in new and nascent clean energy technologies.The IRA will provide $3 per kilogram of solar grade polysilicon, $12 per square meter of PV wafer, 40c per square meter of polymeric backsheet, and so on. 

    We wrote in December that changes made amid the Covid and Ukraine crises could last longer than intended: “Many of the moves are temporary—hurriedly developed and justified as emergency response measures—but they set precedents for which tools count as legitimate. Increasingly frequent crises in the material world can open up new political pathways.”

    Europe may be more intentional than the US in its energy transition policies, but it is also backward-looking. Ahead of a meeting this week of European leaders to discuss the Commission’s proposed green industrial plan, Breton warned that the strategy of reactive tinkering with rules—in response to Covid, then Ukraine, then the IRA—is not suited to a “permacrisis era.” (The comments echoed Isabella Weber’s account of devising the German gas price brake scheme.)

    The demand side

    The bloc is unlikely to achieve its dream of becoming a solar manufacturing superpower as quickly as it would like, but it might have an edge in other ways. 

    Europe and other wealthy countries have rediscovered the merits of intervening in the supply of critical goods, as well as in managing prices. Shaping demand, however, has often been the neglected stepchild of energy transition policymaking. Even the Intergovernmental Panel on Climate Change reports did not deeply explore measures like “social-cultural transitions and lifestyle changes” until the most recent review cycle.

    The importance of demand-side efforts is obvious for critical minerals. The steep projections for EV and renewable energy global boom has created a Malthusian panic. Policymakers are anxious about the geological supply of transition minerals such as lithium, cobalt, graphite—and about the geopolitical implications of China dominating that supply. Such hand-wringing obscures demand-side assumptions. 

    A new report by Thea Riofrancos, Alissa Kendall et al argues demand management is a powerful tool for decarbonization. The paper models how lithium demand in the US could be radically reduced with holistic transportation policy. Fleets of electric Hummers might lead to scarcity and dependence on China, but will certainly involve a chaotic extractive frenzy in global south countries that supply these minerals. Alternative pathways involving more public transport, smaller cars, and recycling could cut future lithium demand by two thirds, simultaneously addressing security of supply, scarcity and price concerns, and destructive extraction. 

    Making these recommended changes are challenging in the US, however, where federal climate policy is all carrot and no stick. Regulatory measures are excluded from the IRA and Credit Suisse estimates that only about 20 percent of the bill’s spending will be focused on the demand side. In Europe, by contrast, there is a stronger political consensus on climate action and, consequently, a systematic effort to decarbonize on all fronts: electricity generation, construction, vehicle manufacturing, industry and mass transit. All this gives the EU more agency over resources.
    The EU’s proposals to bring industry to net zero will go “hand in hand” with its Critical Raw Materials Act. Europe’s approach to critical transition minerals is premised on keeping commodities exporters compliant and away from Chinese influence; the details of the Act smack of colonialism. But its approach of upgrading and replacing old infrastructure, improving car-free mobility, maximizing efficiency, mandating battery recycling, and even nebulous sounding concepts like the “circular economy,” while not as sexy as becoming a solar PV manufacturing superpower, is more engaged with the nature of the challenge.