Category Archive: Analysis

  1. Red Sea Rivalries

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    Every few years, a crisis in the Red Sea makes global headlines. In 2014, the Yemeni Civil War spilled into the Red Sea after the Houthis captured the capital Sana‘a and dissolved the parliament. As a warning, the Houthis allegedly conducted two missile strikes on US Navy ships, prompting a swift but limited retaliation from a US warship. In 2021, a malfunctioning commercial vessel was left stranded in the Suez Canal for six days, obstructing the trade of an estimated $9 billion in commercial goods passing through the Red Sea each day. The scale of the economic impact was so severe that the Egyptian government, which profits from tolls on Suez transport, initially demanded close to a billion-dollar settlement from the Japanese owner of the vessel.

    Since October of 2023, the Houthi organization, the de facto governing authority in Yemen backed by Iran, has launched a barrage of attacks on several commercial ships in response to the war in Gaza and US support for Israel. The goal of these attacks has been to undermine US military presence in the area as well as to restrict the passage of Israeli commercial ships.

    In light of the Houthis’ unprecedented military capability, the US has organized a coalition to secure Red Sea trade. The political implications of these naval operations are momentous. India, for example, has taken the opportunity to flex its own naval might, deploying warships east of the Red Sea in response to its rising concerns about its exports, 50 percent of which travel through the Bab-El-Mandeb Strait.

    This most recent escalation invites a deeper reflection on the history of a small but profoundly important body of water—a history which traverses several centuries and crucially takes place on both sides of the sea, recounting persistent rivalries of great and middle empires. In particular, we can look to Egypt and Ethiopia’s battle for dominance in the Red Sea to contemplate current crises. Their rivalry embroils powers like the United States, Saudi Arabia, and China, extends to the wars in Palestine and Israel, and implicates past and present national claims in the Horn of Africa. While the actors may have fluctuated over centuries, the singular significance of this water passageway to the global political economy has endured.

    Geographies of power

    It is difficult to overplay the Red Sea’s economic importance. At the northern edge of the sea, the Egyptian-owned Suez Canal connects it with the Mediterranean. By extension, the Bab-El-Mandeb at its southern edge serves as the gateway between Europe and Asia. In normal times, up to 15 percent of all global trade passes through the Red Sea, though recent conflicts have cut this volume by nearly half. The current crises in the region have disrupted the supply chain of critical commercial goods, including grains, oil, and natural gas. Given these high economic stakes, it is no surprise that established and emerging powers alike have sought to project naval power in the region. 

    Well before the latest series of crises, the Red Sea served as a battleground for states seeking a higher position within the global order. Much of the focus of these new power contentions has been on the Horn of Africa, lying at the crossroads of the Red Sea, the Gulf of Aden, and the Indian Ocean. Traditionally, the Horn was dominated by the influence of Egypt, the United Kingdom, and France. Beginning in 1896, the latter utilized Djibouti as a strategic hub for its colonial endeavors along the coast, known as French Somaliland. The Djibouti base enabled France to monitor maritime trade routes from the Red Sea to the Indian Ocean and facilitated the expansion of its military operations in the 1930s.

    Power within the Red Sea has shifted throughout the period of US hegemony and then with the emerging multipolar order of the twenty-first century. In 2001, the United States took ownership of the Camp Lemonnier base under the guise of the War on Terror. With its own pretext of combating piracy, China established its first overseas naval base in Djibouti in 2017. The same year, Turkey established its largest overseas military base in Somalia. The Gulf Powers have also been eager to spread their influence west of the Suez; after failing to garner concessions from Djibouti, both Saudi Arabia and the United Arab Emirates (UAE) secured agreements for military installations in Eritrea, another coastal state in the Horn. 

    This diplomatic interest has, since 2018, eroded the traditional geopolitical divide between the Horn of Africa and the Middle East. The Gulf monarchies were quick to assert their influence west of the Suez, investing billions of dollars and brokering groundbreaking peace agreements between Eritrea and Ethiopia. Beyond economic relations, the UAE and Turkey also provided significant security assistance to Ethiopia and Somalia. In response to the complex political transitions in Sudan and Ethiopia, the United Nations created the role of special envoy to the Horn of Africa in 2018, recognizing the limitations of the regional body previously responsible for fostering peace, the Intergovernmental Authority on Development (IGAD). The United States and the European Union, observing this deepening involvement of Gulf states, appointed their own envoys to the Horn of Africa in 2021. This move was largely seen as an effort to counterbalance the growing Gulf influence and to ensure Western interests were adequately represented. China appointed its special envoy to the region in April 2023, underscoring a broader strategy accompanying its infrastructure investments in the region and its reliance on oil imports from Africa and the Middle East. 

    While the major powers of the world have been vying for prominence on both sides of the Red Sea, the Horn of Africa itself has played host to new internal struggles among the lesser powers. In January 2024, Ethiopia brokered a deal to gain access to twelve miles of land for a naval base in the coastal city of Berbera, Somalia, on the Gulf of Aden. The agreement, however, was not with Mogadishu but with Somaliland—Somalia’s breakaway semi-autonomous northern region. As part of the bargain, Ethiopia reportedly granted Somaliland shares in Ethiopia Airlines and agreed to table a process toward a future recognition of Somaliland’s independence. Unsurprisingly, Somalia voiced stringent objections, threatening retaliation if Ethiopia moves forward with the deal. With media attention focused on Yemen’s Houthis to the north, little has been said about these pregnant developments along the Gulf of Aden’s southern shore.

    Renewed tensions among the lesser powers present difficult questions for the stronger powers. The UAE, with a $3 billion stronghold of investments in Ethiopia, has stayed mostly silent on Addis Ababa becoming a coastal power—likely recognizing the enormous advantage to the federation of a partner in the Horn of Africa. Turkey, like the UAE, has significant economic investments in Ethiopia. But with a far more significant military stake in Somalia, Ankara affirmed its support for the country’s territorial integrity while hinting at the possibility of playing a mediator role. The United States, which has long supported greater autonomy for Somaliland, nevertheless criticized Ethiopia’s deal, perhaps over fears of a seismic regional change in which it plays no part. Egypt has indicated a readiness to intervene militarily if Ethiopia moves forward. Compounding tensions between the US and Iran, then, are renewed tensions between Egypt and Ethiopia. The result may be an all-out regional war. 

    A river and a sea

    From a historical standpoint, neither Egypt’s threat to Ethiopia nor Ethiopia’s muted attempt at Red Sea relevance is altogether surprising. In fact, this long-standing rivalry extends beyond the Red Sea to another shared body of water: the Nile. Egypt’s national identity has been inextricably linked with the Nile Valley since antiquity. The Nile flows into Egypt from two main tributaries in Uganda and Ethiopia, the latter supplying 85 percent of the river’s total waters. While Ethiopian folklore has long romanticized the beauty and potential of the river, the Egyptian sense of life and identity has characterized the social nature of the Nile through the ages. The age-old motif that “Egypt is the Nile and the Nile is Egypt” emphasized the Nile waters’ capacity to convert the “desert to garden.”1 In modernity, the river granted Egypt with numerous competitive advantages in cotton production and agriculture, owing to deposits of rich mineral resources carried downstream from the Ethiopian highlands.2 The construction of the Aswan High Dam in 1970 cemented Egypt’s sense of ownership over the Nile. The dam created the artificial Lake Nasser, which thereafter was imagined as the origin of the river and the source of its many benefits in sustaining fertile agrarian lands downstream.3 Today, agriculture in the Nile basin accounts for 11.7 percent of Egypt’s total GDP and 26 percent of the employed labor force.4

    In antiquity, Ethiopia’s influence stretched not only from the Nile basin to the Red Sea, but across the waters to present-day Yemen. In the sixth century, King Kaleb of Ethiopia’s Axumite Empire sailed across the sea with 120,000 men to depose the Jewish King of Himyar, Yusuf As’ar Yath’ar, who had massacred hundreds of Christians in the city of Najran.5 After defeating Yusuf, Kaleb installed a vassal to rule in present-day Yemen, returned to his kingdom, and retired into monastery life. But the conquest of Jewish Himyar weakened the Christian kingdom, which soon confronted the Persian empire in a new war in Himyar—a Persian presence that would persist amid the rise of Islam.6

    Ethiopia’s ability to project power across the Red Sea and conquer southern Arabia helped perpetuate its own image as a great power during the Axumite era.7 However, Axum declined after losing the Arabian territories to Persia around 578 AD. Thereafter, the rise of the Umayyad Caliphate in the seventh century dealt an irreversible blow to Ethiopia’s command of the Red Sea. The Arab empire assumed naval control over the Red Sea and established it as a vital artery for commerce and military expansion. Within two centuries, the crux of Red Sea power had transferred from Ethiopia to Persia and finally to the new Arab empire. After the fall of the Umayyad caliphate, control of the region passed to the Abbasids, whose empire stretched from Baghdad to Damascus. The Abbasids were challenged by the Shia Fatimids, who took control of Egypt in the tenth century. Thereafter, control of Egypt emerged as a proxy for Red Sea dominance. By this point, the Red Sea was not just a major waterway for trade but also a major passageway for religious pilgrimage to Mecca and Medina. As Egypt passed from the Fatimids to the Mamluks and then to the Ottomans, each of these powers, in turn, asserted their power over the sea. The Ottomans utilized the Red Sea most effectively in the seventeenth century, preventing rival European naval powers such as Portugal from gaining ground in the region. 

    Even after Axum’s collapse, future Ethiopian rulers would continue to consider Red Sea power as a projection of strength and prestige.8 However, domination by the Arab and then the Ottoman empires would forestall Ethiopia’s return to the coast. Ottoman-controlled Egypt would finally face off with Ethiopia in the nineteenth century. Egypt was then under the ambitious rule of Khedive Isma‘il Pasha, who envisioned an expansive empire that spanned the entire Nile Valley, reigning over both the river and the Red Sea. After conquering much of Sudan, Isma‘il invaded Ethiopia from the east in 1875, launching his campaign from the Egyptian-controlled port city of Massawa in present-day Eritrea. Contrary to Egyptian expectations, the invasion was met with significant resistance. The overwhelming numbers of the Ethiopian army, led by Emperor Yohannes IV, decisively defeated Isma‘il’s forces, their victory owing in no small part to the rugged terrain of the Ethiopian Highlands. 

    After defeating Isma‘il, the Ethiopian Empire attempted to reestablish a presence on the Eritrean coast. This ambition, however, was short lived, as the Italian colonial mission which landed in East Africa in 1885 would effectively push the empire away from the sea. Still, the southern port of Assab continued to present immense economic potential for Ethiopia, since it was far closer to Ethiopia’s major cities than to Eritrea’s. In recognition of this, Italy had even offered 30,000 square meters of Assab land for Ethiopia to use for 130 years in 1917.9 In 1935, however, Italy sought to expand its colonial empire into Ethiopia. This second attempt was initially more successful than the first, but Italy was once again expelled from Ethiopia at the heels of an allied victory in the Second World War. 

    National ambitions

    The twentieth century forced the modern states of Egypt and Ethiopia to renegotiate their own national identities vis-à-vis the two major water bodies upon which their preceding empires were established. Egypt’s contemporary assertion over the Red Sea came with its independence from Great Britain and the assumption of ownership over the Suez Canal. The Suez presented tremendous economic opportunities for easing trade; prior to the Canal, most goods traveling from countries along the Mediterranean to those along the Indian Ocean were transported either on camels or through circumnavigating the southern tip of the African continent.10 Although the Suez was constructed by a French company, Britain acquired a 44 percent stake in the passageway in 1875 amidst the economic woes of Isma‘il Pasha. Britain expanded its control through the course of the First World War, and gradually completed a treaty with Egypt that granted full control to Britain. 

    The Suez, incidentally, became crucial during the Second World War. Upon gaining independence in 1956, Egypt nationalized the canal, which at the time was jointly owned by French and British companies. Although Egypt temporarily lost control of the canal amid military confrontations with Israel, Britain, and France, its ownership of the Suez was formally recognized by the UN in 1957. Later, Egypt’s blockade of Israeli ships passing through the Suez became a main point of contention during the Six Day War. It was not until the end of the Cold War and the global acceleration of trade that Egypt was able to fully exploit the Suez and, by extension, its influence over the Red Sea.

    Meanwhile, with the defeat of the Italians and the Ethiopian Crown restored, the empire finally regained its presence on the Red Sea. By 1970, Ethiopia had the third largest Red Sea coastline, after Egypt and Saudi Arabia.11 This coastline, however, was far from secure. Eritrea, then a coastal province of Ethiopia, had constructed a distinct political identity through the course of Italian administration. With the departure of the Italians and the weakening of the modern Ethiopian empire, Eritrea began articulating nationalist aspirations of its own in the 1970s, with strong support from Egypt and Saudi Arabia.12

    As these patrons of Eritrean independence show, it was the context of the Arab-Israeli conflict that shaped the Red Sea politics of the 1970s. The Arab League states were keen to emphasize the Red Sea as an Arab sphere of influence—accusing Ethiopia of leasing Red Sea islands to the Israeli military, the presidents of both Egypt and Syria stated unequivocally that the Red Sea is an “Arab lake.”13 In the leadup to the Yom Kippur War of 1973, blockading Israeli shipments required a near-complete Arabization of the Red Sea and coordination of policy among members of the Arab League.14 Fearing that Eritrean nationalism was driven by Arab instigators, who historically used the Red Sea as a base to invade the Abyssinian hinterland, the Ethiopian Crown balked at conceding any autonomy to the coastal province.15

    Given these tensions, the Ethiopian empire was intent on maintaining its sole access to the sea via Eritrea. A United Nations communiqué highlights Ethiopia’s self-perception during this period as a “proud, powerful nation” by virtue of its control of the seas.16 Nevertheless, Ethiopia lost its coastline in 1993 with the independence of Eritrea after a decades-long civil war. Egypt and Saudi Arabia emerged as the main beneficiaries of Eritrean independence, now able to assert their influence unhindered as the two countries with the largest Red Sea coastlines.

    Back to the present

    The histories of Red Sea rivalry form an essential backdrop to contemporary tensions. For the past decade, Ethiopia’s construction on its portion of the Nile river of the Grand Ethiopian Renaissance Dam (GERD), Africa’s largest hydroelectric power plant, has provoked a war of words with Egypt. Breaking ground amid Egypt’s 2011 revolution, the GERD challenged Egypt’s longstanding hegemony in the Nile. The GERD threatens to drastically reduce Egypt’s 85 percent allotment of Nile waters—set by UK-brokered agreements in which Ethiopia took no part—placing Egypt’s water security at the mercy of Ethiopia.17

    This recent rebalancing of power relations with Ethiopia is, for Egypt, unacceptable. A major escalation came with the leaked recording of a secret meeting in which members of the Morsi-led government discussed military action against the GERD. Another was the result of Egyptian air force drills responding to Ethiopia’s unilateral filling of the dam.18 With the GERD now nearing completion, however, an Egyptian-led military strike over the issue is unlikely. In the absence of even a minimal agreement for coordinating joint water use, it is expected that Egypt will continue to seek other opportunities to undermine or weaken Ethiopia’s position. 

    The diplomatic fallout from the Somaliland deal presents Egypt with an opportunity to assert itself over its regional rival. In this sense, Egypt’s threat of military intervention is credible. Unlike a military escalation over the GERD, in which Egypt would be seen as the clear aggressor, an intervention in defense of Somaliland, a weaker independence movement, presents a more feasible opportunity for Egypt to restore its power balance with Ethiopia. As the putative loser of the Nile conflict, Egypt will go to great lengths to prevent its historic rival from re-establishing a presence on the Red Sea. In this respect, both the Nile and the Red Sea have been instrumental to the foreign policies of these regional powers.

    Today’s Red Sea trade exclusively passes through the Suez Canal, accounting for 14 percent of Egyptian government revenue.19 For Egypt, then, the economic implications of Red Sea instability are critical, placing it once again in a vulnerable position before larger geopolitical forces. Furthermore, Ethiopia’s diplomatic triumph in the Nile dispute and its efforts to reassert a Red Sea presence signify a profound strategic dilemma for Egypt, a country intrinsically tied to the Nile and the Suez Canal. The UAE’s gamble on Ethiopia’s resurgence contrasts with its more measured positioning in the Gulf and the broader Middle East. Turkey’s influence in the region is nowhere near that of its Ottoman predecessor, but its security and economic commitments in the Horn have rivaled those of the UAE.

    Iran’s backing of the Houthis is a strategic move to unsettle the status quo, weakening Israel while challenging the dominance of Saudi Arabia and the US in the Red Sea. This maneuver carries echoes of the past: Persia’s challenge against Ethiopian influence in Arabia through the sixth century conquest of Yemen; the tenth-century Shia-Sunni contention between the Fatimids and the Abbasids; as well as the post-World War II Arab blockades of Israel via the Red Sea. The current turmoil has reengaged the United States in Middle Eastern politics and drawn naval interest from China and India. But rivalries to the west of the Suez are now more volatile than those in the Gulf. In the Horn of Africa and the Red Sea, the roots of present-day statecraft run deep. 

  2. The Falling Lira

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    Since late 2021, the Turkish economy has been shattering conventional economic expectations. With deeply negative real interest rates, high inflation, a large and persistent current account deficit, an external debt stock exceeding 50 percent of GDP, and a central bank with net foreign exchange reserves estimated around -$50 billion, the economy has seemed permanently poised for crisis. 

    Just this past year, Turkey’s Central Bank raised interest rates from a low of 8.5 percent in June to as high as 42.5 percent in December. The sudden increase represented a dramatic reversal of course from previous policy. Throughout much of 2022, negative real interest rates had generated a flight away from the Turkish lira, resulting in rapid depreciation of the currency. Given the high level of imported inputs in production, the loss in the value of the Turkish lira meant increased production costs, which were quickly passed onto prices. Inflation spiraled out of control and by August 2022 hit 80 percent.

    Despite the central bank’s policy tightening, Turkish inflation is still running above 60 percent. This is at a time when the unemployment rate is close to 10 percent, with more than half of employed workers earning roughly the minimum wage—itself brought below the poverty line as inflation has rapidly eroded purchasing power. 

    Behind the latest crisis, however, lie two decades of policy that have left Turkey with an increasingly narrow policy space, its economy depending on foreign capital inflows and imported inputs.1 The result has been a mountain of fragilities, including a large and persistent current account deficit and a high external debt stock.

    The IMF success story

    During the late 1990s, Turkey suffered from increasing economic instability and persistently high inflation. The IMF-directed disinflation program implemented in 2000 prompted one of the most severe crises in the country’s history. In early 2001, sudden and rapid capital outflows led to a currency crisis, which quickly turned into a banking and financial crisis. In response, the IMF imposed strict austerity measures, including high interest rates, primary budget surpluses, and a slew of privatizations. This coincided with increasing global liquidity and declining interest rates worldwide, which meant that international finance saw its opportunity in Turkey’s newly introduced higher rates. With the IMF’s imposed privatizations, international investors snapped up cheap acquisitions. Coming to power in 2002, Erdoğan followed the IMF program to the letter and foreign capital began flowing in; by 2006, the ratio of foreign capital inflows to GDP reached 11.3 percent, a historical record.

    The 2008 financial crisis did little to disrupt the pattern. Though capital markets momentarily dried up, quantitative easing in the US, Europe, and Japan eased global liquidity conditions. Once more, Turkey attracted large capital inflows, mostly in portfolio investment and private foreign debt. From 2010 onwards, economic growth continued, with wide current account deficits and increasing private sector external debt. 

    Cracks in the model

    It wasn’t until the Fed’s switch to quantitative tightening in the mid-2010s that the underlying fragilities in the Turkish economy were revealed. Turkey was classified among the so-called “fragile five” by Morgan Stanley, together with Indonesia, Brazil, India, and South Africa—all with large current account deficits and high external debt levels. To deal with the deficits, capital inflows would be needed, which would in turn require higher interest rates. Higher interest rates would mean slowed economic growth; keeping them fixed, on the other hand, would generate depreciation pressures on the Turkish lira. Turkey was faced with a classic dilemma: raise the interest rate to keep the exchange rate stable but tolerate slower growth—maybe even a recession—or keep the interest rates low but tolerate the currency’s depreciation—maybe even a currency crisis.

    A series of elections from 2015 to 2019 compounded the crisis: with rising political instability, Erdoğan’s governments prioritized economic growth over long-term economic strength. For example, in 2017, it used its Credit Guarantee Fund, a facility initially designed to support small and medium enterprises, to support credit expansion. With economic growth, however, came large current account deficits. Once capital inflows slowed, depreciation pressures on the Turkish lira increased. The tower came tumbling down in 2018, with a currency crisis followed by interest rate hikes and a recession.  

    It was evident that the good old days of high economic growth, low inflation, low interest rates, and low exchange rates were over; they had always depended on massive foreign capital inflows. But in the aftermath of the pandemic, the global economic environment had changed. Not only have the global conditions that supported these inflows changed, but the fragilities that these inflows generated over time were now threatening growth and stability. In 2020, another round of interest rate cuts, this time to support the economy during the pandemic, would bring the country to the brink of a balance of payments crisis in the fall of 2020 as capital outflows continued. It also turned out that the central bank had used most of its foreign currency reserves to stabilize the exchange rates while keeping interest rates low. In fall 2020, another round of interest rate increases began stabilizing the foreign exchange markets. 

    Interest rate experiment

    As structural weaknesses rose to the surface, high interest rates could no longer attract adequate amounts of foreign capital. In 2021, domestic firms struggled as export markets demanded further currency depreciation. 

    Just as global interest rates began their upward climb, Erdoğan initiated his low-interest rate experiment. Key to this was Erdoğan’s decision to replace the finance minister and the governor of the central bank overnight with non-orthodox figures who supported lower rates. 

    The government argued that lower interest rates would boost productive investment and that currency depreciation would trigger import substitution, thus ridding Turkey of its chronic current account deficits. In fact, currency depreciation quickly spiraled out of control. When the new round of interest rate cuts began in the fall of 2021, an accelerating flight away from the Turkish lira and lira-denominated assets emerged, sending the currency into freefall.

    This resulted in an increased demand for foreign currency. With Turkey’s high dependence on imports, the depreciation increased domestic price levels and inflation skyrocketed. Some depreciation had been desired, but the government had not expected the free fall that eventuated. When people began rapidly selling their Turkish lira denominated assets to buy foreign currency, the government introduced “exchange rate protected deposit accounts” in a bid to tame the demand for foreign currency by guaranteeing domestic residents a return equal to the rate of depreciation in domestic currency. These accounts denominated in Turkish lira carried the promise of the government and the central bank that if the depreciation rate were to exceed the interest rate, the account holders would be compensated for the difference by the central bank or the Treasury. This was supported through indirect central bank interventions that aimed to manage a more orderly depreciation of the currency. The government and the central bank used borrowed foreign exchange reserves to meet this demand, while introducing “exchange rate protected deposit accounts” for domestic residents to prevent further dollarization of savings. The use of borrowed reserves to intervene in the currency market by the central bank resulted in negative net reserves and made it increasingly difficult to carry on the low interest rate policy. 

    The rapid rise of inflation sent the real interest rates plummeting to record lows. While “exchange rate protected deposit accounts” successfully curtailed domestic residents’ foreign currency demand, capital controls on lira-foreign currency swaps between domestic banks and the London market, first implemented in the aftermath of the 2018 currency crisis, prevented currency speculation. Yet, widening current account deficits in 2022 made this policy course increasingly challenging to sustain. In the absence of sufficient foreign capital inflows, the central bank was using borrowed reserves (both from domestic banks and foreign central banks) to prevent another currency shock. With presidential elections scheduled for 2023, the government had been unwilling to give up the expansionary impact of negative real interest rates—only to change course once the elections were won. 

    As high inflation persisted, wage increases lagged and, in most cases, did not compensate for declining real wages. All the while, firms adjusted their prices and even increased profits. High inflation and low interest rates not only allowed the firms an opportunity for debt-financed investment but also resulted in debt-financed speculation, especially in real estate. The result was an unprecedented decline in the labor share of income.

    Austerity loading

    While the government may have had some success in maintaining growth in the economy whilst keeping employment levels relatively high, the tumbling value of the Turkish lira plus high inflation rates have meant immiseration for many. 

    Broader lessons can be gleaned from the Turkish case, particularly with regard to the limited policy space available for developing and emerging economies that are highly integrated to the global economy through open trade and financial flows: namely, having an independent monetary policy is not possible without capital controls. This brief period of expansionary monetary policy was only feasible thanks to selective capital controls (preventing swap agreements between domestic banks and London to minimize currency speculation), heavy central bank interventions in the foreign exchange market, and new financial products such as “exchange rate protected deposit accounts” curbing domestic residents’ demand for foreign currency. 

    Even then, this experiment ground to a halt in June 2023 when Erdoğan opted to appoint a new finance minister and a new central bank governor to appease the powerhouses of international finance capital. It is now becoming increasingly apparent that, once again, the burden of adjustment will be put on labor as wage increases lag behind inflation and high interest rates and austerity policies are likely to increase unemployment. 

  3. Miracle in Reverse

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    The South Korean economy is widely seen as the paragon of the East Asian miracle, characterized by its rapid economic growth and a fairly equal income distribution. The country continued its upward growth trajectory even in the aftermath of the 1997 financial crisis, emerging as a global leader in manufacturing semiconductors, automotive, and batteries. But the South Korean economic outlook has proven far less hopeful since the dawn of the twenty-first century. Income inequality began to rise in the early 2000s, and Korea now is home to the lowest birth rates and highest suicide rates in the developed world. In 2017, President Moon Jae-In attempted to change course, introducing a progressive income-led growth strategy. Through more active state intervention, the policy focused on increasing household consumption and promoting aggregate demand. Five years into its government, however, the administration lost its leadership and was replaced by the current conservative government of Yoon Suk Yeol. Keynesian wage-led growth has been replaced with trickle-down economics, with poor prospects for growth and redistribution. What went wrong? Examining the trials and tribulations of South Korea’s experiments with income-led growth reveals important implications for fiscal policy and the enduring influence of austerity.

    Reversing the miracle

    In 1997, foreign capital flowed rapidly out of East Asia, beginning from Southeast Asian countries that had high foreign debt and vulnerable economic fundamentals. Korea was no exception: its corporate sector had made substantial debt-financed investments, and its economy had lots of foreign short-term debt. Across the West, the crisis was explained as the result of crony capitalism and political interference in market processes. Grossly overlooked were the reckless financial openings and government retreat from economic management since the 1990s. 

    Accepting a $57 billion bailout from the International Monetary Fund (IMF), the Korean government adhered to the predominant reading. The East Asian growth miracle was the culprit. In response, the government implemented neoliberal, market-led economic reforms, including corporate restructuring to reduce debt ratios, financial restructuring involving substantial public funds, and labor market flexibilization measures. Progressives expressed serious concerns that post-crisis restructuring would bring an end to the previously successful growth model, leading to economic stagnation and worsening income inequality.  

    These predictions were partially verified. After 1997, investment growth and the economic growth rate declined. The economy as a whole, however, continued to grow, thanks to the resilience of major business groups known as the Chaebol, and effective government promotion of information and technology (IT) industries. 

    The global economy also played a crucial role in sustaining Korea’s economic growth during the early 2000s. Currency depreciation combined with a global economic boom led to surging exports between 1999 and 2000. When China was admitted into the World Trade Organization (WTO), the export share of GDP in South Korea rose from 28.6 percent in 2002, to 47.6 percent in 2008—primarily led by Chinese imports of intermediate and capital goods. This trend intensified after the Global Financial Crisis, as massive Chinese stimulus measures drove the Korean export share of GDP to its peak in 2011 at 54.1 percent. Despite such turbulence, South Korea held a current account surplus in the mid-2010s and managed to achieve export-dependent economic growth.

    But important changes were taking place under the surface. In particular, the share of domestic consumption contributing to economic growth declined throughout the 2000s.  In the mid-2010s, the share of private consumption was less than 50 percent of GDP, significantly lower than that of other advanced countries. This growth pattern was associated with rising income inequality and wage depression. The Gini coefficient of disposable income rose, and the wage share of workers fell significantly in the 2000s, though there was some improvement after 2010. Notably, the relative poverty rate reached 17.6 percent, and the share of low-wage workers receiving less than two thirds of the median wage stood at 23.5 percent in 2016. By contrast, the rich fared well, with the top 10 percent income share at about 43 percent of GDP in 2016, second only to the US. 

    In the face of stagnation and inequality, Koreans called for “economic democratization”—the distribution of income from the Chaebol companies to vulnerable workers in small and medium enterprises.  In response, the conservative Park government of 2012 introduced a universal pension system for the elderly, partially embracing the reform agenda but implementing tax cuts and deregulation. Ultimately, Park was embroiled in a corruption scandal and impeached amid a wave of public protests and political resistance. 

    The income-led growth strategy

    Moon Jae-In came to power in 2017,  criticizing former conservative governments for adopting trickle-down economics and prioritizing export-led growth. The new government-proposed economic paradigm was a Korean version of wage-led growth, promoted limited government redistribution, and boosted aggregate demand by increasing wages and household incomes. This approach was broadly consistent with inclusive growth promoted by international organizations after the global financial crisis. As part of its reform efforts, the government raised the minimum wage by 16.4 percent in 2018 and 10.8 percent in 2019, and offered incentives to small companies that hired minimum wage workers. It also raised the Earned Income Tax Credit (EITC) and offered subsidies for social insurance premiums for self-employed workers, who constituted 25 percent of the total labor force. Furthermore, the government expanded social welfare by raising the elderly pension benefit, introducing child benefits, and expanding unemployment insurance. Finally, it reduced the costs of medical care, child care, and housing, increasing the budget for these sectors by more than 10 percent in 2018 and 2019. Total public social expenditure as a percent of GDP rose from 10.1 percent in 2017 to 12.3 percent in 2019.

    The first year of the Moon government saw significant setbacks: only one-third of the number of jobs were created in 2018 compared with 2017, and income inequality was found by the Household Income and Expenditure Survey (HIES) to rise rapidly. Faced with overwhelming criticism, the Moon government loosened its commitment to income-led growth and changed the presidential economic advisor.

    Not all of the criticisms, however, were justified. For example, the HIES which found rising inequality underwent a change in sample and population group in 2018 and experienced limitations in accurately capturing changes in inequality using quarterly data. The more credible Survey of Household Finances and Living Conditions (SHFL), which provides official income distribution statistics with results published much later than the HIES, showed that income equality has clearly fallen since 2018. The Gini coefficient of disposable income of households fell from 0.354 in 2017 to 0.339 in 2019, and 0.333 in 2021, and the relative poverty rate fell too. The share of low-wage workers fell from 22.3 percent in 2017 to 17 percent in 2019, alongside a significant reduction in wage inequality. The adjusted wage share also rose from 68.1 percent in 2017 to 72.2 percent in 2019. Income-led growth did, after all, succeed in raising incomes of workers and households. 


    While wages in South Korea were rising, wealth inequality and concentration worsened thanks to a rapid increase in real estate market prices. The price of apartments in Seoul nearly doubled between 2017 and 2021, increasing the Gini coefficient of net wealth from 0.584 in 2017 to 0.603 in 2021. The very high real estate prices compared to income are particularly noteworthy, significantly higher than that in other advanced countries. For example, the ratio of total net national wealth to net national income was 9.5 in 2017, rising to 11.9 in 2021 due to the rapid increase in housing prices. 

    At the same time, meaningful growth failed to materialize. The GDP growth rate fell from 3.2 percent in 2017 to 2.9 percent and 2.2 percent in 2018 and 2019, respectively. The total fixed investment growth was -2.2 percent in 2018 and -2.1 percent in 2019 because of the fall in both equipment and construction investment. A decline in equipment investment was closely associated with the change in exports to the global market. Korean exports increased by 15.8 percent in 2017 but only by 5.4 percent in 2018 and -10.4 percent in 2019. The semiconductor industry’s exports surged by 64.7  percent in 2017 but its growth fell to 27.5 percent in 2018 and -28 percent in 2019, leading to a significant reduction in investment growth. The growth of equipment investment in the consumer electronics and petrochemical industry also increased rapidly in 2017 but declined in 2018 and 2019. Government statistics report that the growth of the index of machinery and equipment investment was 20 percent in 2017 but fell to -5.3 percent in 2018 and -10.2 percent in 2019. This was mainly driven by the fall in investment in special industrial machinery and equipment, including the equipment used in semiconductor production. While private consumption growth had become the largest contributing factor to economic growth in 2018, it was not powerful enough to offset the decline in industrial investment. 

    Where did Moon’s policies go wrong? First, the government failed to implement an effective tax on real estate in 2017. By the time it did so, the real estate bubble had already generated widespread complaints about the higher tax burden. Second, the Moon government neglected to articulate and implement a clear fiscal policy. It reduced the budget for Social Overhead Capital (SOC) by 14 percent and decreased construction investment by about 1 percent in 2018. Fiscal stimulus was important for mitigating the potential shock of income-led growth policies, such as the rapid increase in the minimum wage. While tax revenues left the budget with its highest budget surplus since 2007, no supplementary budget spending was planned, resulting in de facto austerity.

    The inactive stance on fiscal policy reflected the strong influence of conservative government officials and a persisting ideology of austerity. While the gross public debt as a percentage of GDP was less than 40 percent in 2018, concerns about fiscal deficits and rising government debt persisted in Korea. The president and his advisors in the presidential office appeared not to have strong political will and capacity to pursue active spending. This contradicted even the mainstream Keynesian macroeconomic argument to support fiscal stimulus when the economy is in stagnation and the interest rate is low. The fiscal policy of the Moon government thus fell desperately short of its Keynesian aims. 

    Last, but not least, the Moon government experienced the impacts of a changing global economy. Escalating tensions between the US and China significantly decreased trade growth in 2019, reducing export growth to -10 percent in 2019 in dollar terms. With unfavorable global economic conditions, the challenges to growth were nearly insurmountable. 

    Future paths

    Reservations about fiscal spending persisted throughout the Covid-19 pandemic. While wealthy governments spent an average of 11.7 percent of GDP on pandemic mitigation between early 2020 and mid-2021, Korea’s spending stood at just 6.4 percent. Consequently, self-employed workers in Korea faced severe economic hardships and the already high level of household debt increased from 98 percent of GDP in 2019 to 108 percent in 2021. This, in turn, was met by public disapproval of the government, particularly among the self-employed.

    Elections in 2022 saw conservative candidate Yoon Suk Yeol win the presidency by a tiny margin. The government’s return to trickle-down economics was marked by tax cuts for large companies and the wealthy alongside fiscal consolidation. In 2023, tax revenues are anticipated to fall short of expectations by 15 percent due to stagnation and cuts. The government has introduced an exceptionally restrictive budget for 2024, significantly reducing spending on R&D and social programs. In stark contrast to its narrative of successful growth, today South Korea turns away from state intervention just as economies across the world begin to embrace industrial policy. 

    The international economic environment has also worsened, with US export regulation in the semiconductor industry poised to harm Korean production. Thanks to the development of its own intermediate and capital goods industry, China has also recently reduced imports from Korea—declining by 16 percent in 2019, mainly due to the fall in exports of intermediate goods. By August of 2023, exports to China fell by 25 percent compared to the same period in 2022. Between the stagnation and economic upgrading of the Chinese economy, Korean exports are in a bind. 

    With this as the backdrop, the growth rate in Korea is expected to be a mere 1.4 percent in 2023 according to the IMF. If South Korea is to reverse course, it must reap the lessons from both its export-led and income-led growth turns. Chief among these is that increased consumption must be coupled with a more active role of the government in promoting social welfare and public investment. The reduction of income inequality by enhanced government redistribution is necessary to boost domestic consumption. Fiscal spending to address challenges related to the population is crucial, considering the extremely low birth rate of 0.78 in 2022 and the highly elderly poverty rate of 38 percent in 2021. Finally, active public investment and industrial policy must be called on to develop green industries and address climate change.

  4. External Imbalance

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    In August 2023, a week after winning Argentina’s primary elections, now-President Javier Milei publicly stated that the Argentine peso was “worth less than excrement.” Over the next two days, the dollar-peso parallel exchange rate climbed almost 20 percent, intensifying the already rapid devaluation of the currency. Such extreme proclamations were common for Milei, who as a candidate combined libertarianism with global right-wing extremism and placed proposals to abolish the central bank and dollarize the national economy at the center of his campaign. 

    Milei’s rise must be understood within the context of Argentina’s extraordinary inflation in the past two years. In 2022, the annual consumer price inflation was 72.4 percent, placing Argentina among the five countries in the world with the highest inflation.1 In 2023, the situation became dire—the year-to-year CPI increased to an astounding 142.7 percent in the last measure from the Argentinean National Bureau of Statistics. 

    A similar trend can be observed in the dollar-peso exchange rate, which went from $173 in December 2022 to $357 in November 2023.2 The fall of the peso in the parallel exchange rate is even more pronounced. In December 2023, both the financial exchange rate and the informal exchange rate were around $1,000, representing an increase of more than 185 percent from December 2022.

    The weakness of the peso and spiraling inflation spurred popular support for Milei’s dollarization proposal. The instability of the economy, however, is linked to a fundamental external problem in the Argentine economy. The challenges of Argentina’s external accounts are not due to faltering commercial or economic competitiveness. Rather, they can be attributed to the nation’s longstanding financial constraints, a byproduct of Argentina’s role in the global economic hierarchy.

    Argentina’s external accounts

    Several studies locate the roots of Argentina’s financial liberalization in 1976, when the military regime overthrew Martínez de Perón and commanded control of the government. In 1977, the regime implemented a financial reform that included the liberalization of interest rates, free credit allocation, and an easing of the restrictions to enter the financial market. This reform accompanied greater openness to capital and goods markets. 

    The fall of the military government in 1983 and the return to democracy saw Raúl Alfonsín elected as president. In a period characterized by the Latin American debt crisis and a lack of external financing for the region, Alfonsín’s economic policy was focused on solving the external debt problem; his administration largely kept the military government’s financial reforms in place.3 By the end of Alfonsín’s administration in 1989, the economy was in the throes of hyperinflation and stagnation.  

    It was in this context that in 1990—under the recommendations of the Washington Consensus—the state reinforced the neoliberal policies of deregulation and liberalization. After renegotiating external debt through the Brady Plan, Argentina recovered access to the international markets, using this access to sustain the one peso-one dollar parity. During the ensuing decade, the magnitude of capital flows to and from Argentina began to rapidly grow. The average annual gross capital flows from and to Argentina were $29.9 billion between 1990 and 1999, a growth of more than 800 percent compared to the previous decade. Portfolio investment—speculative in nature with a short-term horizon—became more prominent in the flows to Argentina during this period.4 In 1999, capital started to flee Argentina, a result of international financial conditions after several financial crises wreaked havoc on emerging countries around the world. This reversal of capital flows forced Argentina to break the one peso-one dollar convertibility in January 2002, with the peso devaluating more than 300 percent in eighteen months.

    From 2003 to 2015, Argentina’s accumulation mode shifted to one centered by production and distribution. During these twelve years, the average annual growth rate of the economy remained around 5 percent, with growth fueled by an expansion in production of goods, specifically industrial goods. Internal demand also rose, testifying to the recovery of real wages after the default and the devaluation of the peso in 2001–2002. Importantly, this period saw the renegotiation of external debt to achieve reductions in principal and interest. But a shift occurred in 2008 with the onset of the global financial crisis. From 2003–2007, Argentina expanded investment, exports, and fiscal, and commercial surplus. From 2008–2015, the financial crisis caused capital accumulation to decelerate, the effects of which can be seen in the reemergence of the external debt constraint in recent years.5

    In 2015, President Mauricio Macri—the former Mayor of Buenos Aires who won as the head of the “Alianza Cambiemos,” a conservative, center-right coalition—reintroduced deregulation policies and proceeded to liberalize the external accounts office. In the first year following the liberalization, between 2016 and 2017, net inflows from direct and portfolio investment plus loans to public and private sector totaled more than $40 billion. However, a major portion of these inflows were speculative short-term capital. In March 2018, the global financial conditions tightened through an upward shift in US interest rates and these inflows abruptly stopped—the net flows turned negative, and Argentina had to request IMF assistance. By 2019, Argentina had a massive external debt (mostly denominated in foreign currency) and received the largest IMF loan in history.6 The government introduced capital controls—a last resort measure that while successful in stopping the ongoing devaluation of the peso, only in effect after the peso had already depreciated 40 percent between July and October 2019. By the time Macri left office in 2019, following a failed reelection bid, the country was on a path to crisis. 

    The exchange balance

    The country’s scarcity of foreign currency since 2019 has laid the groundwork for the current dilemma. In 2021 and 2022, Argentina accumulated a surplus in the current account of almost $10 billion,7 but international reserves only grew by $1.6 billion.8 The gap can be attributed to the difference between the official exchange rate and the parallel exchange rate. With capital controls in place, the official real exchange rate appreciated, and the economy saw a huge injection of money from pandemic-era social protection measures. But disequilibrium arose in the parallel exchange rate, and as a result, major exporters engaged in tax avoidance to escape to the official exchange rate market. Debt and interest payments from public and private sector loans and bonds, as well as the remission of utilities, also drained foreign currency from international reserves.

    To convey these developments in detail, we draw on the “exchange balance” of the Argentinean Central Bank (BCRA). The chart below shows the evolution of purchases and sales of foreign currency carried out by private entities through the exchange market and the operations carried out directly by the Central Bank. The chart disaggregates the main items comprising the current, capital, and exchange financial accounts. 

    Main components of the exchange balance of Argentina, 2021-2022. In Millions of US dollars.

    Source: Own elaboration with BCRA data.

    The figure above demonstrates that even during periods with favorable trade of goods and services, financial components of the external accounts drain the trade surplus. Although the nation saw a trade surplus of more than $22 billion between 2021 and 2022, the BCRA international reserves only grew by $6.8 billion during those years. Even more, the $6.8 billion increase can be almost entirely explained by the growth of the international reserves in 2022, a year when Argentina received net loans from different multilateral organisms.

    Two financial components stand out in this analysis of the commercial surplus: net interest payments, and private loans and bonds. The net interest payments include government and private sector payments. Private loans and bonds represent the net indebtedness of the private sector. These findings demonstrate that the huge debts of the private and public sector from 2015 to 2019 still influence the external account through interest and capital payments.

    The private sector was responsible for the bulk of capital payments during this time, despite the fact that between 2020 and 2022, the BCRA implemented different measures to limit the impact of private sector capital payments on international reserves. This included requiring firms to refinance at least 60 percent of debt maturities for a minimum average term of two years, and compelling firms to use their own foreign currency (liquid external assets deposited abroad) before being allowed to buy foreign currency in the official exchange rate market to pay debts. The BCRA also restricted the payment of debt from one company to another related company.

    This precarious balance plunged into a full-on crisis in 2023, after a severe drought descended upon wide swaths of the country. Commodity exports—particularly soybeans—fell dramatically, with ripple effects across the economy. In the first ten months of 2023, Argentina exported $56.5 billion compared to $75.2 billion in the same period of 2022. The fall in exports significantly reduced the trade surplus, making it difficult for the BCRA to contain the exchange rate and maintain international reserves. The chart below displays the main components of the exchange balance for 2023.

    Main components of the exchange balance of Argentina, January-October 2023. In Millions of US dollars.

    Source: Own elaboration with BCRA data.

    The financial situation of 2023 closely resembles 2021-2022 with regards to net interest payments and private loans and bonds. The sum of both net interest payments and private loans and bonds in the first ten months of 2023 led to $11.4 billion drag in the Argentinean external accounts, a similar amount to 2021 ($10 billion) and 2022 ($11.95 billion). Still, between January and October of last year, the BCRA lost more than $20 billion in international reserves due to the shrinking balance of trade (which fell to $5.7 billion) after the decline in exports. The trade balance fell by $16 billion in a single year, from 2022 to 2023. Another factor contributing to falling reserves: between January and October, Argentina saw net outflows of capital from multilateral organizations, a stipulation of the EFF program negotiated by the IMF and Argentine government in March 2022.

    The financial constraint

    Our findings demonstrate that Argentina’s structural problem is financial, not commercial. Huge debts owed by the private and public sector, interest, and capital payments drain the trade surplus, while capital inflows tend to be short-term, speculative, and therefore volatile. This has important implications for corrective economic policy going forward. While exports are significant, solely focusing on restoring the trade balance by increasing exports will fail to resolve the financial component of the external debt. 

    Argentina’s external financial constraint can be linked to the transformations in global finance that have taken place since the fall of Bretton Woods. As the financialization literature has long argued, unprecedented growth in capital flows has increased their influence in the external accounts of peripheral countries over the past several decades.9 In this sense, the vulnerability of the peso can be framed in what post-Keynesian literature calls the “currency hierarchy.”10 Currencies at the bottom of the hierarchy are used as “investment currencies,” while the currencies at the top are “reserve currencies.” As a consequence, capital flows to the countries whose national currencies are at the bottom of the hierarchy—a category containing most of Latin America—are more volatile, procyclical, and dependent on international financial conditions. Reducing the external vulnerabilities of peripheral countries would require reforming the dollar-based international monetary system.

    At the same time, peripheral countries differ depending on distinct structural characteristics of their economies, such as the level of financial openness and the stocks of international reserves.11 Argentina—characterized by a high degree of liberalization in external accounts and dwindling international reserves—must then adjust its domestic economic policies accordingly, implementing internal financial reforms that allow it to accumulate international reserves and strengthen the peso. Such internal shifts could occur alongside global monetary reform, saving nations like Argentina from deepening financial and social crises. With this aim, Argentina could reintroduce exchange control policies adopted by Nestor Kirschner’s administration between 2003 and 2010, such as a minimum-stay requirement for foreign capital inflows, while still maintaining the competitiveness of the exchange rate. Although domestic assets are necessary for the success of these policies, Argentina’s elite actors have tended to safeguard their earnings abroad. Domestic financial reform must therefore also include restrictions on the capital classes of peripheral countries, including a limit on foreign currency held as savings or transferred abroad by firms. Of course, enacting such measures would entail a challenging political project, especially in the aftermath of Argentina’s triumphant right-wing reaction.

  5. Learning Curves

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    Over the last ten years, the surface of the Earth warmed by another 0.5°C. At the same time, renewable energy grew its share of world electricity production from 5 to over 11 percent. These are the basic coordinates for the ongoing turn in global climate policy—from meting out taxes and penalties to promoting technologies that can substitute fossil fuels. Dealing with climate change feels more urgent than ever and also—for the first time since it emerged as an object of global politics in the 1990s—like a technical and economic possibility.

    As a result, the boundaries between climate policy and economic policy are more porous than ever. Countries around the world are recasting their strategies for claiming a greater share of global value-added in the language of the energy transition, and launching new subsidy and incentive programs to support domestic industries with green credentials—the USA’s Inflation Reduction Act is the paradigmatic example. It’s no surprise that organizations ranging from ExxonMobil and OPEC to Bloomberg New Energy Finance (BNEF) and the International Renewable Energy Agency (IRENA) produce so many forecasts, roadmaps, and scenarios predicting how much energy the world will consume in 2050, and where that energy will come from.

    The headline takeaways from these modeling exercises vary widely, with some predictable differences—ExxonMobil predicts that demand for oil and gas will grow 13 percent by mid-century, while BNEF predicts it will fall by 7 percent. However, they share a family resemblance. All of them rely on some kind of least-cost optimization framework, solving for the cheapest, most efficient global energy system possible, given whatever external constraints modelers choose to impose, like a maximum level of emissions. While modelers represent the global energy system at different levels of complexity, from one system planner with perfect foresight to multiple agents with distinct preferences, all of these approaches require some notion of costs to decide which technologies should be used to meet energy demand and which should be left on the shelf.

    The most pervasive way of representing how costs will change over time is through the concept of the experience curve—an idea that followed a strange, circuitous path through the twentieth century on its way to become a load-bearing element of thinking on climate policy. The “experience curve” (sometimes called the “learning curve” or “Wright’s Law”) concept was first codified by the aircraft engineer T.P. Wright in a 1936 paper titled, modestly, “Factors Affecting the Cost of Airplanes.”

    Wright drew the experience curve as a straight line on log-log paper, with axes representing the labor cost of producing a certain model of plane and the cumulative number of planes produced. In short, he was making the empirical observation that certain kinds of costs declined at the same rate each time production doubled, a ratio since dubbed the “learning rate” of a technology.

    Over the ensuing decades, other authors found that experience curves seemed to fit the cost trajectories of technologies as varied as DRAM, PVC, and magnesium. Auspiciously, the concept was also championed by the Boston Consulting Group (BCG), starting in the 1960s. BCG used the experience curve in a new setting, taking a tool originally designed for cost accounting within a single firm and making it a bigger-picture framework for competitive analysis. It also expanded the definition of costs to include “R&D, sales expense, advertising, overhead, and everything else.” Despite these changes in scope, the concept came with a seductive rule of thumb that dates back to Wright’s original paper—that learning rates cluster around 20 percent.

    Experience curves have long been controversial among economists, who tend to argue that they conflate learning-by-doing with factors as varied as economies of scale and a firm’s bargaining power with suppliers, and that they often represent a spurious correlation rather than a causal relationship. Nonetheless, they continue to be in wide use by industry and policymakers. By the late 1990s, the International Energy Agency (IEA) was promoting the use of the experience curve as a tool for policymakers sizing “learning investments” in new technology.

    Early examples of government policy to drive clean-energy adoption—solar heating for swimming pools in Germany, distributed solar panel installations in Japan, and wind turbines in Northern Europe—showed that cleverly designed subsidies could help new technologies realize self-reinforcing cost reductions, eventually finding “docking points” in niche markets and, from there, reaching full commercial scale. Twenty years on, the language of “learning investments” and “docking points” has transformed into calls for “catalytic capital” to drive “commercial lift-off” but the thinking behind it is largely the same.

    The experience curve concept really does map well onto reality for certain technologies. Over the last decade, the cost of utility-scale solar projects fell by 70 percent, and the cost of onshore wind farms by 39 percent. Lithium-ion batteries have fallen in cost by 82 percent. Solar, wind, and battery manufacturing are all likely to keep growing apace—BNEF estimates that these three technologies will see installed capacity grow by 4.6 TW by 2030, as compared to 2.1 TW of total capacity in-place today. At the same time, green industrial policy is increasingly directed at a range of earlier-stage technologies—“green” hydrogen, carbon capture and storage (CCS), long-duration energy storage (LDES), and advanced nuclear—where future learning rates are much less certain.

    Not all technologies “learn” much with scale. Construction costs for nuclear power plants rose alongside cumulative capacity in many countries from the 1970s to early 1990s, including the US, Japan, and West Germany, while more recent nuclear build-outs in India and South Korea have been only a little more successful, managing to hold costs flat or slightly down (by 1 to 2 percent per annum) in real terms. We need to be clear-eyed about whether support for a specific industry is a down payment on future cost reduction, or a carbon tax by other means.

    The ongoing crisis facing the offshore wind (OSW) is a case in point. Year-to-date, developers have canceled over 7 GW of planned OSW generation capacity, with more projects delayed or “under review.” For a sense of scale, only 8.4 GW of OSW was installed in all of 2022. Though projects in other countries are getting cancelled too, the OSW crisis centers on the US, where the Biden administration hopes to grow the industry from a standing start, adding 30 GW of capacity by 2030.

    The root cause of the industry’s problems is that OSW projects take a very long time to reach fruition. In the US, the Sunrise Wind project, a joint venture between Ørsted and Eversource Energy, initially leased an area fifteen miles off Rhode Island from the Department of Energy’s Bureau of Ocean Energy Management (BOEM) back in 2013, won a deal to sell renewable energy credits to New York State in the summer of 2019 (which it will potentially re-bid), and offshore construction is slated to begin in April 2025. That implies an over six-year journey from pricing the clean-energy credits sold by the project to the start of offshore construction work, let alone “first power.”

    Implicitly, this was a highly leveraged financial bet on the spread between inflation and the OSW industry’s learning rate. In 2019, when Sunrise Wind’s energy credits were priced, the unsubsidized cost of OSW power was about $150.1 If a project locked in revenue at that price point, with no recourse to inflation adjustments, and construction costs ended up just 10 percent higher than planned, it would cut the rate of return for equity investors in half. Developers do try to limit their exposure to unexpected cost increases by locking in prices with key suppliers, like turbine manufacturers and construction vessel owners, well in advance, and, in certain cases, hedging their exposure to changes in the cost of key raw materials like steel, neodymium and copper. But, in 2019, before the post-pandemic commodity squeeze, the cost of wind turbines had fallen by nearly 40 percent over the last six years. It would only be rational to retain some of the risk related to changing prices for turbines and other inputs if you extrapolated that trend into the future.

    As we now know, this was the wrong bet. Procurement processes for OSW off-take agreements are adjusting to this new reality—for example, the latest New York state OSW solicitation added a one-time inflation adjustment feature to the awarded contracts. OSW project developers like Ørsted have had to write off billions of dollars of assets after walking away from projects that no longer make financial sense. And the political opponents of OSW smell blood in the water.

    Whether that is a “crisis” has little to do with what has actually happened with the cost of OSW power, and more to do with the expectation that costs would rapidly fall. The reality is that if we look at the most mature market for OSW (Europe), construction costs for OSW installations have fallen by a little under ~$300 per kW a year, in real terms, since 2010, but there has not been a pronounced trend in either direction since about 2018, just a lot of ups and downs. Interest rates have gone up, and a number of key commodity prices, like steel, are well off their highs but still elevated versus pre-pandemic levels. Putting all this together implies an unsubsidized cost of offshore wind somewhere in the $120-150 range, still higher than typical peak power prices in the US or corporate power purchase agreement (PPA) prices.

    So this is a maturing industry, that may never be competitive with new-build gas-fired power plants on an apples-to-apples, unsubsidized basis. That doesn’t mean that it’s not deserving of government support. The Northeast US has few decent options for low-carbon power, with less sunshine than the Southwest and slower wind speeds than the Great Plains. New nuclear power plants face political opposition, and recent US experience with nuclear projects (i.e. the Vogtle project in Georgia) has been disastrous, with fully-loaded construction costs exceeding $10,000 per kW, over three times the cost of new-build nuclear reactors in Asia. Calculating the “social cost of carbon” is more art than science, and using the more aggressive estimates recently floated by the EPA would suggest that power from modern natural gas plants is underpriced by some $70 per MWh. Significantly, this implies cost parity with OSW, if CO2 emissions were to be fully taxed at this price.

    Nonetheless, this is not how OSW, and, indeed, green industrial policy as a whole have been sold to the public—as a strategy for incubating domestic low-carbon industries that will soon be able to stand on their own two feet. The key point is that we have to put the experience curve in its proper context, as just one intellectual tool, with its own particular history and baggage. Otherwise we risk getting sideswiped by cases where it doesn’t apply.

    Not every industry we need to scale to decarbonize our economy will have a high enough learning rate to reach cost competitiveness with incumbent, fossil-fuel-based technology. And in some cases, the experience curve concept may not apply at all, given it is better suited for thinking about routinized manufacturing processes than site-specific mega-projects. Green industrial policy is well suited to saving promising, but expensive technologies from being “locked out”—a real case of innovation market failure. Over the next decade, we are going to learn in real time which technologies it works well for, and which it doesn’t. Building a political coalition that can see this new, more aggressive kind of climate policy through to 2050 will require accepting that a risk-taking, market-shaping state is not going to win every bet.

  6. Anarcho-Capitalism

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    Since the early 2000s, Argentine development finance has undergone a profound transformation.1 Amid cyclical debt defaults and endless negotiations with Western investors and the IMF, Chinese overseas investment loans have slowly crept to the fore. Between 2007 and 2020, Argentina received $10.65 billion in investment from Chinese companies, concentrated in the energy, mining, and financial sectors.2 Today, Argentina is the fourth-largest recipient of Chinese loans in the region, securing around $17 billion in total. These loans have primarily supported transportation infrastructure, energy projects, and the enhancement of Argentine exports. In 2022, President Alberto Fernández agreed to open financing lines with China totaling nearly $23 billion through the Strategic Dialogue for Economic Cooperation and Coordination (DECCE) and Belt and Road Initiative, though the latter is still pending activation.

    It’s within this changing borrowing landscape that Javier Milei, the self-defined “first true free-trade reformer and libertarian president in the history of the world,” has been elected. Milei won the ballot against the former Minister of Finance, Sergio Massa, in a country with 140 percent inflation rate and plummeting exports thanks to a drought that resulted in a $19 billion loss, nearly 3 percent of Argentina’s GDP. 

    Economically, Milei raises a sense of déjà vu reminiscent of neoliberal figures from the 1970s, 1990s, and the Macri era. His political party and cabinet are drawn from earlier administrations, with figures like Ricardo Bussi (son of the dictator and governor of the Tucuman Province), and members from Menem’s administration, including Menem’s nephew, Martín Menem, as president of the Senate. Notably, a significant number of former ministers from Macri’s government—Patricia Bullrich, Luis Caputo, Santiago Bausili, among others—have also joined Milei’s cabinet.

    Milei advocates for radical free trade reforms and a robust adjustment policy. Hoping to usher in a new era of substantial indebtedness from Western finance, he originally pledged to sever ties with “communist” governments like China and Brazil and notoriously promised to dollarize the economy and dismantle the Central Bank. 

    But less than a month since his election, Milei’s orientation towards China saw a dramatic shift: Argentina currently holds a net Central Bank reserve of negative $10 billion, with gross reserves amounting to $23 billion, 75 percent of which are tied up in a swap arrangement with China. When the Chinese Embassy suspended the arrangement, Milei was ironically forced to apologize to Xi Jinping in his first political move. But Milei’s letter was not enough—China suspended activating the 47 billion Renminbi (equivalent to $6.5 billion) of the swap.

    The trajectory of Milei’s orientation towards China raises questions regarding deeper developments in the global financial landscape. It suggests that there’s more at stake than ideology alone—that in certain contexts, the US and its affiliated financial institutions can no longer credibly claim to finance the development needs of the global South, and that Chinese investment is here to stay. Furthermore, it indicates that not all global South countries are equally empowered by rising geoeconomic competition. On the contrary, some find themselves doubly trapped between the global powers. 

    Debt Cycles

    In December 1982, Argentina’s central bank nationalized nearly $17 billion of private debt, concluding a period of Kissinger-backed dictatorship characterized by some of the earliest experiments with neoliberal restructuring. The decision paved the way for the debt crisis of the 1980s and subsequent deindustrialization and adjustment reforms policies in hand with social repression. 

    The Argentine economy has remained on this cyclical trajectory since: significant borrowing triggers an economic crisis which is then used to justify austerity measures and privatization. Rather than stimulating economic growth, these measures often worsen the crisis and prompt a period of capital outflow.3 In subsequent elections, the ruling center-left coalition refrains from challenging the cycle, choosing instead to renegotiate and repay the debt. 

    It’s because of this pattern that former President Cristina Fernández de Kirchner designated Argentina as a “serial payer.” The strategy can have temporary gains in favorable exogenous circumstances, like a commodity boom. But during an international recession, the strategy couples with structural adjustment policies and sparks enormous dissatisfaction. The right-wing coalition eventually returns to power. 

    Figure 1: Argentina as a “Serial Payer”: Gross debt by currency as a percentage of GDP

    Source: Central Bank of Argentina. In blue, debt in pesos; in green debt in foreign currencies.

    Argentina’s debt cycle has been persistently stimulated by its toxic relationship with the IMF. In 2018, the disastrous effects of IMF lending reached new heights, surpassing Argentina’s debt-bearing capacity and sparking a capital outflow that contradicted IMF statutes.4

    IMF policies have been guided by a distinct political agenda: Mauricio Claver, the executive director at the IMF and a crucial adviser to the Trump administration on Latin America, asserted, “Everything Trump did at the IMF was to assist Macri and prevent Peronism from returning to the ‘Casa Rosada’ (Argentine Presidential Palace).” By prioritizing the exclusion of the political left, these policies inadvertently opened the way for the right.

    Luis Caputo, now serving as Milei’s Minister of Economy, previously held the same position during Macri’s administration. Caputo, an economist with a background at JP Morgan and Deutsche Bank, implemented a currency flight mechanism via the Central Bank during Macri’s tenure. This involved dollar auctions below market rates, resulting in a substantial loss of 66 billion pesos. The connection of this loss to funds from Macri’s record IMF loan was later revealed, raising concerns about financial outflows. In a surprising revelation, Milei himself stated in a 2018 interview, “Caputo sold out, he smoked $15 billion from the IMF, and he’s responsible for the disaster in the Central Bank.”

    Figure 2: Most Indebted Countries with the IMF, in USD Billions.

    Upon assuming power, former President Alberto Fernández government pledged to break away from neoliberalism and chart a path toward growth. However, the debt restructuring led by then Minister of Economy Martín Guzmán, involved requesting a new loan from the IMF within the framework of the Extended Facilities Program (EFP) and gaining approval in Congress. Historical evidence indicates that structural adjustment programs, be they “soft” or “strict,” have consistently fallen short of resolving issues in Latin America, often exacerbating them instead.5

    The agreement itself proved to be inflationary and significantly curtailed the government’s ability to implement assertive policies against inflation. Following the formalization of the agreement with the IMF, Guzmán resigned, and Sergio Massa, a seasoned politician, assumed the role of Minister of Economy. 

    An Opening for China

    It’s in the aftermath of decades of lending on the part of Western institutions that China has risen as an appealing alternative. Chinese loans hold significant advantages over their Western counterparts. While Western finance comes with domestic political and economic conditionalities, China offers non-conditionality loans for large infrastructure projects. After a five to ten-year grace period, recipient countries are expected to pay back the loans thanks to the economic growth they are expected to generate. 

    Chinese loans do require Chinese technology to constitute 30 to 40 percent of the recipient country’s imports, broadening China’s export markets. Overall, Western finance has been way more speculative and short-term than the Chinese “patient” capital.6 As Table 2 indicates, state-to-state loans from China to Argentina using sovereign guarantees amounted to nearly $7.8 billion, and most of the financing lines went to transport and energy projects.

    Table 1: Comparative table between Western and Chinese Finance in Argentina

    AspectWestern FinanceChinese Finance
    Conditionalities– Domestic political and economic conditionalities.
    – Mostly related to adjustment programs. 
    – Geopolitical conditionalities
    – Non-domestic policy conditionalities. 
    – Tech clause: Minimum 30-40% of Chinese technology imports to boost Chinese exports.7
    – Cross-default clauses: If one project stops, all are affected.
    Cycle– Speculative and short-term 
    – Doesn’t generate repayment conditions
    – Usually outflows of the country
    – Linked to US financial expansion
    –Related to projects in the real economy (hydro-dams, solar plants, export lines, etc.) 
    – Expects to generate repayment conditions 
    – Swaps are long term, “patient” capital.8 They do not cost anything prior to activation. 
    – Linked to Chinese material expansion.
    Interest Rate– IMF: Around 10%– Chinese loans and swaps are lower than market interest rates. 
    – Loans around 3%, swaps around 6%.
    Adaptability– Low– High
    Source: Elaborated by the author.

    Table 2: Loans channeled by development banks from China to Argentina (2010-2019). By lending agency, project, amount, interest rate and maturity.

    YearLending AgencyProjectMillion USDInterest ratesMaturity (years)
    2010China Development Back (CDB) y CITICSupply of locomotives, passenger wagons, spare parts, tools, technical documents, technical service and technical training for the San Martín Railroad273Libor + 3.15%10
    2010Export-Import Bank of China (CHEXIM)Supply of passenger wagons, spare parts, tools, technical documents, technical service and technical training for the San Martín Railway114Not available8
    2014China Development Back (CDB) y ICBCRehabilitation of the Belgrano Cargas Railway21006-months Libor Libor + 2.9% interest rates, 0.125% commitment,
    and 0.20% management fee
    15.5 (with a grace period of 4.5 years)
    2014China Development Back (CDB); ICBC y Bank of China (BoC)Hydroelectric dams on the Santa Cruz River47146-months Libor Libor + 3.8% interest rates, 0.125% commitment,
    y 0.20% management fee
    15 (with a grace period of 5.5 years)
    2017Export-Import Bank of China (CHEXIM)Cauchari I, II and IIIA photovoltaic solar parks331Interest rates 3% (Preferential Buyer Loan – PBL) + 0.75% commitment fee and 0.75% management fee15 (with a grace period of 5 years)
    2019China Development Back (CDB)Acquisition of rolling stock for the Roca Electric Railway2366-months Libor Libor + 2.4% margin10 (with a grace period of 3 years)
     Source: Secretariat of Strategic Affairs of Argentina (2023)

    Chinese swap lines have played a crucial role in stabilizing Argentina’s macro-economy since 2009, strengthening the country’s reserves in the Central Bank without additional costs if used as a reserve mechanism. Since 2008, the People’s Bank of China has engaged in bilateral swap agreements (BSAs) with foreign central banks, utilizing these agreements to offer short-term liquidity support to partner countries beyond the Bretton Woods institutions. Argentina has been a significant beneficiary of these agreements. The initial currency swap, valued at 70 billion yuan ($9.98 billion), was inked in 2009 between the People’s Bank of China (PBoC) and the Central Bank of Argentina (BCRA) during Cristina Fernández de Kirchner’s presidency.

    In 2017, under Macri’s administration, the PBoC and BCRA renewed the bilateral currency swap agreement for 70 billion yuan. An additional currency swap deal for 60 billion yuan was signed in 2018, expanding the total to 130 billion yuan (US$20 billion). In 2022, Alberto Fernández renewed and extended the swap with China to 150 billion yuan (US$23.4 billion). During Sergio Massa’s tenure as Minister of Economy, two additional tranches were enabled: the first, equivalent to $5 million, and when depleted, a second tranche was activated for $6.5 billion. From this latter amount, funds were allocated to make three payments to the IMF in yuan: on June 30 for $1.08 billion, on November 1 for $796 million, and on the seventh of the same month for another $884 million.

    Table 3: Argentina Central Bank’s Reserves, disaggregated August 2023

    ConceptUSD Billion
    1. Gross International Reserves23.8
    Gross liabilities
    — Swap lines   
    — China         
    (Of which activated)   
    — BIS
    RR FX deposits
    Other (incl. deposit insurance) 
    — SEDESA 
    — Other
    2. Net International Reserves-10.3
    Liquid reserves
    Memorandum item 
    Nominal Interest Rates (program definition)
    Central Bank Non-deliverable forward position
    Sources: Elaborated by the author based on FMI and BCRA.

    Chinese Trade and Industrial Transformation

    Increased Chinese investment comes with a price. Since the early 2000s, China has overtaken Argentina’s traditional economic partners, including the United States and Europe. Currently, China ranks as Argentina’s second-largest trading partner, following Brazil. Typically, Chinese trade constitutes 8 to 10 percent of Argentine exports. However, Argentina’s trade balance has experienced growing deficits, particularly with China and the United States. 

    Figure 3: Argentina’s Trade Balance with the US and China

    While China escaped from “shock therapy” policies,9 Argentina suffered the consequences of recurrent neoliberal waves, the industrial development in the countries experienced bifurcating paths.10 This led to a significant shift in the productive matrix, as Argentina underwent deindustrialization thanks to the increased demand for raw materials and natural resources.11

    Figure 4: Percentage of the Participation of the Industry in the GDP of Argentina and China.

    Source: Elaborated by the author based on the World Bank.

    Increased trade with China has only intensified the shift. Soybeans constitute the leading export from Argentina to China, equaling one third of the total. Fulfilling Chinese demand for soybeans has, in turn, entirely transformed the Argentine economic landscape.12 Figures 5 and 6 illustrate the profound imbalance in the diversity of exports and imports between the two countries. 

    Figure 5: Argentina Exports to China

    Source: OEC, MIT (2023)

    Figure 6: Argentina Imports from China

    Source: OEC, MIT (2023)

    Structural constraints

    Milei is not the first Argentine leader to resist growing economic ties to China. Since 2015, the Macri administration has aimed to curtail cooperation and emphasize a geopolitical alliance with the United States. But then, too, economic realities forced the government to reverse course. During the first seven months of Mauricio Macri’s government, China reduced soybean imports by 30 percent and soybean oil imports by 97 percent. During the 2016 G20 meeting in China, Macri managed to restore the soybean trade. Because Chinese-financed projects often include a “cross-default” clause that guarantees the cessation of all projects if one is halted, repercussions for pulling back are enormous. 

    Milei’s orientation towards China, then, is nothing new. Despite its solidifying economic reality, Argentina remains wedded to its alignment with the West. But like administrations before him, Milei will have to come to terms with the changing composition of the global economy: repaying Argentina’s debt to the IMF depends on continued exports to China. 

    Milei’s failure to find fresh financing from Western lenders may compel his administration to accept Chinese economic diplomacy, leading to a situation similar to Bolsonaro’s administration in Brazil.13 This may result in a strengthened economic reliance on Chinese hands. However, while Brazil is capitalizing on Chinese relations with an important trade surplus, innovation centers, and New Development Bank funds, Argentina will go to China as a “desperate debtor.” China is pressing Milei to confirm that his administration will maintain Chinese interest in Argentina.  

    Argentina’s case thus brings to light two harsh realities. The first is that Chinese financing and investment across the global South fulfills a structural need rather than a political choice. The second is that, while the emergence of competing superpowers typically opens up opportunities for global South countries, it can also trigger a downward spiral. As is often the case, Argentina stands as an exception, caught in pendular shifts without a clear international strategy.

  7. A Year in Crises

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    When we launched The Polycrisis a year ago, we set out to examine the intersecting crises in the economy, energy system, commodities markets, geopolitics, and climate. Our aim was to break intellectual and political silos to give a fuller picture of what’s going on: security and climate, political economy and commodities, domestic and foreign politics, macroeconomics and populism. In the meantime, our world crisis of ecology, economics, and empire, has continued to metastasize. It is, as Nancy Fraser put it, shaking confidence in established worldviews and ruling elites everywhere.

    In twenty-eight newsletters, ten articles by contributors, and four panels with experts so far, we have mapped four main shifts:

    Global South left high and dry

    A new Washington Consensus has arrived. Following the passage of the Inflation Reduction Act (IRA), Biden officials from Jake Sullivan to Janet Yellen have emphasized that the world can and should follow the US in its new passion for productivism. Food and energy import bills are not only a climate problem, they point out, but a security concern. Indeed, nearly every import is increasingly scrutinized through a security lens, down to Chinese garlic.

    The vision, then, is for localized, manufacturing-led green growth, erring on the side of redundancy rather than just-in-time production. All countries, the story goes, should be able to achieve prosperity through derisking, paired with local content restrictions, higher taxes, and subsidies for key sectors like clean energy, biotech and digital infrastructure.

    There is only one small problem. After overhauling its internal investment regime, the US has thwarted any meaningful structural changes to the global financial architecture. On IMF quotas, voting shares, taxation, and even on its measly contribution to the new Loss and Damage Fund, the US has been conservative and isolationist. There have been a few consolation prizes—Barbados’s PM Mia Mottley won debt payment pauses for natural disasters; the IMF will give slightly more interest-free loans to low-income countries—but, on the whole, the global financial safety net continues to ensnare, rather than rescue, the most vulnerable countries.

    For every $1 the IMF provides to poor countries for social spending, it demands $4 in cuts in public spending. Countries do everything they can to delay and avoid bailouts since, when they come, they reduce domestic policy space and autonomy, and force countries to choose between debt repayments, social spending and climate.

    The situation is not entirely hopeless. Norway, which has historically acted as a mediator between the North and South, has made $150 billion in oil and gas profits from the Ukraine war. Like the UAE, it may rechannel some of this windfall to underwrite the risk of green investments in developing countries. But we are far from seeing any coordination that could  rival even the New International Economic Order of the 1970s—let alone the kind of South–South solidarity needed to tackle the climate crisis.


    The past two years have seen more violent conflict than at any time since the end of World War II, according to the Uppsala conflict data program. Conflicts have broken out in many continents. In Africa, there have been over half a dozen coups, with combat fighting in the Congo and Sudan, and now a teetering cease-fire in Ethiopia. In the Middle East, Israel’s assault on Gaza threatens to expand into a regional war. In Europe, Russia’s brutal war of attrition in Ukraine has strikingly altered the political scene. After months of European and US support for its ally, including aggressive sanctions, the US Congress is left in a deadlock on the question of funding Ukraine’s resistance. The result in a multipolar world? Russia’s economy has been decoupled from Europe’s but thanks to its trade with countries in the East and South, its treasury remains flush with cash. We wrote about how the EU is preparing for Ukraine’s accession, and the all important question of who will pay to reconstruct the country?

    On October 7 2022, the US launched an economic war against China. Biden issued a sweeping set of export controls aimed at restraining Chinese military modernization efforts by controlling advanced AI chips made with US inputs. The chips embargo was buttressed by the Pentagon’s largest ever military spending bill—$840 billion—with nary a murmur from inflation hawks. New US bases to be built in the Philippines and Papua New Guinea further cemented Beijing’s view that the US plans to encircle it and prevent its future growth. The panic about an impending war that set the tone during the first half of 2023 soon subsided with a series of crisis stabilization cabinet-level meetings and a constructive meeting between Biden and Xi in San Francisco in November.

    Everyone is nonaligned: Venn Diagram representation of how countries votes in UN General Assembly votes in favor of ceasing hostilities in Ukraine and in Palestine (Source: Alonso Gurmendi)

    In the present context of a dangerous and differentiated world system, categories like “global South” and “global North” may no longer work. This is because, as Patrick Porter has argued, the global South isn’t simply comprised of “aggrieved cultures,” victims bearing wounds, but of ruthlessly self-interested nation states—much like those in the global North. Paying attention to regional actors and their rivalries and partnerships is key. Countries in the South are split on calling for a ceasefire in Ukraine and Palestine. For example, Brazil has called for a ceasefire in both cases, India in neither; Bangladesh and South Africa for a ceasefire in Palestine only; the Pacific Islands in Ukraine but not Palestine.


    Around the world, workers are striking in a way not seen in decades. Betrayed by the US Congress in the IRA legislation, unions across America are taking it upon themselves to make the EV transition good for workers. A dispute between the US and the EU last year over the IRA meant that union-made cars did not get fatter subsidies. The United Auto Workers have fought back in an escalating series of strikes led by Shawn Fain in the US and Marie Nilsson—head of IF Metall, Sweden’s largest industrial union—has led a similar fight among Nordic unions fighting against Tesla.

    Trade defiance

    For most of 2023, it seemed that  free trade had given way to “friend-shoring,” largely on grounds of national security. Predictions of a crackup in global trade patterns abounded. New policies on export controls, visa bans, investment blocks, and sanctions are now redirecting the flow of goods and people. We dug into the narrative to find that 2023 has seen an all-time high of goods traded across borders. Even bilateral trade between China and the US was at a record high of $400 billion in 2022. Firms are responding to geopolitical crackup by diversifying their supply chains into new countries. Bloomberg analysts identified which countries benefited—Indonesia, Mexico, Morocco, Poland, Vietnam—to which we added India and Australia

    Assessing and Looking Forward

    What we got right and wrong

    • US policy elites underrated the seriousness of chips export controls—we expected these would provoke a furious response from Beijing and US allies in East Asia and Europe. By the year’s end, US policymakers’ decoupling rhetoric softened into “derisking.”   
    • We expected a wave of debt defaults with record high interest rates, but only saw a few. Why? Commodity exporting countries showed surprising resilience as they earned higher dollar revenues.  
    • We anticipated a geopolitical crisis in Asia with Chinese aggression. This didn’t happen. There were lots of military flashpoints but only a North Korean rocket scare in Seoul—part of North Korea’s record year of weapons testing—plus some skirmishes in the Himalayas and in the South China Seas.
    • We expected greater coordination among BRICS countries. We got this half-right. We’re seeing BRICS prioritizing local currency settlements and boosting African trade and investment. A troika of India, South Africa, and Brazil are leading reform of the Bretton Woods institutions during their G20 presidencies. Here, it remains to be seen whether the developing world will achieve the greater autonomy and coordination it aims for, or remain fragmented. Either way, one should have no illusions about the radicalism of a new non-aligned movement. The ruling elites of these countries are rarely concerned with carving out more policy space and autonomy for their publics. As William Shoki tartly put it, BRICS is only ever the anti-imperialism of the ruling class.

    The year ahead

    There are forty national elections slated for next year, the effects of which will cover 41 percent of the world’s population, in countries representing 42 percent of global GDP. These votes also represent approximately the same percentage of global emissions, with fossil-fuel industry interests well-represented. 

    We anticipate an anti-incumbency wave of world leaders over the next twelve months as voters elect heads of state in Mexico, South Africa, Russia, UK, US, India, Indonesia. Even a single election—Argentines have just elected libertarian dollarizer Javier Millei—has global consequences. Alongside nations, the European parliament and a host of other representative bodies are also going to the polls. Population movements may complicate polling predictions in several elections, given that the UNHCR anticipates that up to 130 million people will be displaced and in need of protection in 2024.

    “In the last 200 years, since the beginning of the industrial revolution, it has been the rich nations that ‘have polluted the world’ and not the African or Latin American peoples. They must pay the historical debt they have with the planet Earth. We cannot accept a green neocolonialism that imposes trade barriers and protectionist policies under the pretext of protecting the environment.” – President Lula, Paris Global Financing Summit, June 2023

    Lula will occupy center stage in 2024 as Brazil takes on the global reform agenda in its G20 presidency. Frustration with the US and Europe’s so-called green protectionism may frame the G20 and BRICS meetings. Lula may well amplify the anger expressed by many global South nations at this month’s climate summit, especially when Brazil hosts COP30 in 2025. Since China and India have already threatened to make formal complaints about EU’s carbon border adjustment mechanism, Lula’s intervention could be key at the WTO.

    Barbados PM Mia Mottley’ successful advocacy of climate resilient debt clauses has raised hopes for a more systematic rethink of the G20’s Common Framework on debt resolution. It is creaking and may soon be replaced given Zambia’s public creditors, including China, just “derailed” a deal brokered with private creditors under the Framework. 

    These issues may transform 2024 from the year of elections into the year of finance. British Foreign Minister David Cameron has flagged a return to treating Aid as a mechanism to lever-in more private cash. This will rely on new mechanisms and private finance’s willingness and ability to meet the gaps. Recapitalisation of multilateral development banks, new SDR issuance, or a New Collective Quantified Goal (NCQG)—a major theme to-be for next year’s UN climate summit in Baku—will be the focus of discussions.

    We end at sea. Houthi rebels are poised to seriously disrupt the global economy with their actions in the Red Sea, in solidarity with Gaza’s besieged population, forcing ships to re-route around Africa. Meanwhile, thanks to drought, cargo ships in the Panama Canal are now stuck, holding up another major trade passage. Unlike the rather comical scenes of that large boat wedged in the Suez Canal in 2021, images from Panama fail to raise even a chuckle. We’re no longer dealing with the errors of a single human being, but with the tragic collective error of burning such vast amounts of fossil fuels, long after we should have stopped.

  8. Constitutional Odysseys

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    On September 11, 1980—seven years after Augusto Pinochet seized power from democratically elected Salvador Allende in a brutal US-backed military coup—the dictatorship passed a constitution that laid the groundwork for one of the world’s earliest and most enduring neoliberal experiments. The results of this experiment have been well documented: with the privatization of education, pensions, health, public transportation, and essential natural resources like water, Chile became one the most economically unequal countries in the OECD. 

    The protests that erupted over rising transportation fares in October 2019 forced a national reckoning around this political and economic infrastructure. Weeks of mass strikes and public protests reinvigorated discussion about Chile’s future. A year later, nearly 80 percent of the country’s citizens voted in favor of a new constitution in a nationwide referendum. With the 2021 election of social democratic candidate Gabriel Boric—a former student activist who gained prominence through the campaign for a Constitutional Convention—it seemed that a political transformation was underway. 

    But the path forward has proved meandering and vague. In September 2022, the Convention’s proposed constitution, one of the most progressive in history, was rejected by 62 percent of the public. A far-right Constitutional Council, elected in June of this year, has since proposed a new, right-led charter. On December 17, the country will return to vote on this constitutional proposal, marking the culmination of a fierce battle over Chile’s identity. 

    The Boric government’s dramatic reversal of fortune is the result of conflict over the position of indigenous communities within the Chilean state, the patriarchal mobilization against feminist demands, and the role of the state in economy and society. On this final point, the ongoing debates on the Chilean constitution reflect deep-rooted divisions that have plagued the country throughout its recent history.

    Dictatorial inheritance

    Chile served as the experimental testing ground of the Chicago School, which pioneered the wholesale privatization of crucial services and resources, deregulated labor and financial markets, and constitutionally enshrined the independence of the Central Bank. The key innovation of this period was policy “neutrality”—abandoning focused sectoral promotion and allowing market rules to determine the fundamental questions of the economy. Financial liberalization and free trade were the core elements of this economic transformation.1

    During the 1970s, regulations were lifted on interest rates, credit expansion, and bank reserves. The resulting proliferation of private banks and alternative financial entities were at the core of the 1982 banking crisis, after the indiscriminate increase in debt, which resulted in a 14 percent reduction in GDP and unemployment surpassing 20 percent.2 Equally, the gradual elimination of import tariffs fostered the exploitation of existing competitive advantages based on natural resources and eroded the competitiveness that certain domestic industries had maintained.

    Positioning the state as a subsidiary to the private sector, the dictatorship replaced the public pension system with one under private administration in 1981. New financial institutions called “Pension Fund Management Companies” were established to receive individual contributions from workers. These institutions then determined pensions based on the individual’s accumulated savings during the workers’ formal years of employment. 

    The dictatorship similarly privatized the healthcare system. Chile’s National Health Service was divided into a public (FONASA) and a private (ISAPRE) system. In line with the state’s reduced role in healthcare provision, primary care was delegated to local governments. After years of implementation, Chile’s public healthcare expenditure is among the lowest within the OECD, while private spending ranks fifth. As is reported by the OCDE, the private household spending on healthcare can exceed 30 percent of the family budget.

    In contrast to the radical shift from public to private participation in the pension system and health, the privatization of education occurred more gradually. In higher education, the government legalized the opening of private universities and technical training centers in 1981, while integrating private companies into the management of publicly funded elementary and middle schools. Across the education system, private provision rapidly expanded, forcing a significant part of the public sector to adhere to market rules in delivering educational services. A prime example is state universities, which, due to low state funding, now charge tuition fees and must compete on equal footing with private universities to attract students.

    This economic infrastructure far outlived the dictatorship. During successive center-left administrations from 1990 to 2010, economic growth was achieved while the constitution remained intact, following the slogan “continuity in change.” The first such period was between the end of the dictatorship and the financial crisis of the late 1990s: Chilean GDP grew more than 7 percent per year as a result of the non-tradable economic activity. Reforms of this period revolved around increasing investment, reducing external shocks, and raising social expenditure through higher taxation. The disastrous unemployment and poverty rates which followed the dictatorship were rapidly reduced during the ‘90s. 

    Despite these notable achievements, no structural economic reforms were made. This was evident in both the role of the state concerning the provision of social rights and in the scope of horizontal economic policies. A key obstacle to economic reform was the political structure outlined in the constitution, which included the participation of appointed senators among whom was the former dictator Augusto Pinochet. The constitution also established an electoral system (the Binomial System) that favored the election of two political blocs in the parliament, undermining a proportional representation system that would enable the participation of third-party forces. The majoritarian nature of the electoral system made it challenging to build coalitions for constitutional reforms.

    After lengthy negotiations (2000-2005) among the political forces of the period, fifty-eight constitutional reforms were successfully approved in 2005. While these were the most extensive to date, they all aimed at reforming the political system rather than the economic infrastructure: the protection of property rights and the role of the subsidiary state would continue to form central pillars of Chilean policymaking. Meanwhile, the Chilean economy maintained a clear path towards open trade, marked by the signing of several free trade agreements that further expanded the extraction of natural resources.3

    Subsequent years would see early signs of turmoil. In response to the election of a right-wing coalition led by Sebastián Piñera between 2010 and 2014, student protests gave way to a center-left government under Michelle Bachelet. This administration integrated political sectors previously excluded from government, like the Communist Party, in an effort to transform elements of Chile’s reigning economic model. During this period, and for the first time since 1980, new issues were publicly questioned. The country’s pension system was failing: the average pensions paid by the AFPs were $181,297 in 2013 (approximately $340 as of December 2013), and the state was spending heavily to subsidize the retirement of informal workers who couldn’t make contributions. Education saw a similar fate. The lack of state intervention and public spending (state universities only received 12 percent of basic fiscal funding) meant that by 2013, 77 percent of spending on higher education came from Chilean families.

    Among President Bachelet’s key proposals was a constitutional change. While her ambitions were thwarted by a right-controlled parliament, her government saw the emergence of new left-leaning political groupings like Frente Amplio, out of which Gabriel Boric emerged. 

    In March 2018, Sebastián Piñera assumed the presidency again, preserving the political model that had dominated the Chilean economy since Pinochet’s fall. But the model continued to wear thin, distancing political parties from their traditional electorate—while 53 percent of Chileans identified with a political party in 2006, only 19 percent did so in 2019.

    Social outbreak

    On the heels of these developments, in October 2019, Minister of Transportation Gloria Hutt raised Santiago’s metro fare. Under the slogan “It’s not thirty pesos, it’s thirty years,” students’ refusal to pay increased fare quickly catalyzed weeks of intense protests, where thousands expressed their dissatisfaction with the Chilean political and economic system.

    Amid criticism of the country’s education, health, and pensions systems, the call for a constitutional reform united different sectors of society behind a single demand. The successful popular referendum of October 2020 gave birth to the Constitutional Convention in July 2021, and Gabriel Boric was elected president shortly thereafter.

    Entering with what seemed like an enormous mandate, Boric’s proposed reforms sought to address the key complaints emerging from the social protests. The most prominent demands centered around privatized and unequal pensions, education, and healthcare systems; the selling off of natural resources; and the rampant political abuse and corruption limiting public participation in the political process. 

    With gender parity and representation for Chile’s indigenous peoples, the Constitutional Convention was one of the most progressive in history. The drafting process centered indigenous territorial rights and a commitment to feminism. Chile’s indigenous population, which constitutes 12.8 percent of the total, has historically suffered from high levels of poverty and racist discrimination. Their ancestral territories have been systematically violated by the Chilean state, particularly during Pinochet’s dictatorship

    During the social outbreak and the proposal for the new constitution, the clash between the Western territorial identity logic defended by the Chilean state and the communal indigenous identity logic became evident. The concept of plurinationality and interculturality was proposed as a new political project, wherein within the same state, the plurality of nations would be recognized, allowing self-determination. The coexistence of indigenous legal systems and the Chilean national system would be established, each responding to the oversight of the Supreme Court. 

    The constitutional convention also foregrounded feminist concerns, which had risen to prominence in Chile before 2020. Feminist university occupations in 2018 and the memorable protests of March 8, 2019 addressed femicides and the exploitation of feminized bodies.4 One of the most prominent constitutional reform proposals from this sphere was the defense of the freedom of choice for pregnant people regarding gestation, childbirth, and motherhood. This included, among other measures, the legalization of abortion. Additionally, the convention proposed a gender-equal democracy where all state bodies would be required to meet gender parity, and the state would guarantee the right to freedom of sexual and gender identity.5

    The constitutional proposal also included significant changes regarding the role of the state in the economy. First, it expanded access to healthcare, education, and pensions, overturning the subsidiary state for the first time since the dictatorship. While the proposal maintained room for private sector involvement in these areas, it ensured the provision of services as a right guaranteed by the state. Second, it questioned the market’s role in strategic sectors. It upheld property rights at the same time as it made exceptions in areas such as environmental conservation and the defense of strategic resources, such as water. Water—currently managed by private entities through usage-rights purchases—was declared a “public-use good,” thus transferring its ownership to the nation.

    The rejection

    In September 2022, the constitutional proposal was rejected, with 61.8 percent against and 38.1 percent in favor. In one of the largest elections in Chilean history, thirteen million Chileans cast their votes, representing 86 percent of the electoral roll and almost double the turnout of the initial plebiscite in 2020. Roughly five million people who did not vote in the previous plebiscite did so in 2022, and the 7.8 million votes against the constitution exceeded the total number of votes in the initial plebiscite. Rather than representing the loss of supporters, the defeat of the constitutional proposal can be best explained by the attraction and mobilization of new voters.

    This mobilization is in large part tied to the media. Chile’s two major newspapers (El Mercurio and La Tercera), have achieved an elite-funded informational duopoly that significantly impacted the result of the election.6 This had a direct impact on the fact that, in the months prior to the rejection, the Convention’s proposals on gender, indigenous rights, and the environment were deemed unsustainable. The media also presented the lack of incentives for growth and the inadequate protection of private property as major threats.

    Opponents argued that the new Constitution, aimed at guaranteeing social rights, would lead to an unsustainable increase in fiscal spending. The Center for Public Studies published an analysis by well-known center-left economists estimating an additional fiscal cost increase ranging between 8.9 percent and 14.2 percent of the GDP.7While the study presented somewhat unrealistic assumptions, it also omitted the multiplier effect of public spending, thus reinforcing the false narrative that the constitutional proposal was impractical. 

    Debates surrounding the pension system were emblematic of this discourse, as one of the citizen initiatives supported by the right called “not with my money” started gaining space in the media. On March 30, 2022, a well-known national publication ran the headline: “Workers will no longer be owners of their pension savings” Shortly after, the “Reject” motion began to lead over “Approve” in opinion polls. Gradually, the demand for a present and rights-guaranteeing state for basic needs such as education, healthcare, and fair pensions shifted towards a fear that the state would infringe on private property and individual rights. The circulation of fake news and misinformation exacerbated these trends, associating the new constitution with the rejection of national symbols, Chilean traditions, and civic education; the expropriation of pensions and homes; and the rising levels of crime.

    In this context, the media campaign against the proposed constitution successfully represented the Boric government as extreme and the opposition as moderate. For instance, on September 3, 2022, columnist Luis Larraín asserted in La Tercera:

    “[If the Rejection wins] ultimately, the excessiveness, politically represented by the Broad Front and the Communist Party, will have lost. Instead, moderation and common sense will have won.”

    While the government and the constitutional convention were independent of the ruling government, the rejection of the latter was interpreted as a popular disapproval of Boric’s administration. Although the economy was experiencing the effects of imported inflation and post-pandemic economic slowdown, it was precisely after the rejection of the new constitution that Boric’s administration began to face heavy criticism, especially around economic matters. In March 2023, for instance, the Boric government’s proposed tax reform was rejected, and a widely-cited public opinion poll found that voter disapproval rose sharply following the referendum. 

    Another vote

    Elected by popular vote on May 7, 2023, the new Constitutional Council is primarily composed of members from far-right. While it has maintained gender parity, the body has not ensured indigenous representation. Beatriz Hevia, president of the new Council, presented the project as a statement “for the true Chileans (…) those peaceful, honest, hardworking individuals.” In the same speech, she asserted that both those who led the 2019 protests and those who politically supported them are responsible for the destruction and looting of the country. 

    Unsurprisingly, then, the newest constitutional proposal has taken a sharp turn to the right, allowing for immediate expulsion of foreigners who entered irregularly, rejecting the plurinational state, repealing the limited right to legal abortion established in 2017, and denying public rights over water and other natural resources. In many ways, the proposal signals a revival of the values espoused by the dictatorship, refusing to address the demands of the 2019 protests and upholding the economic model enshrined in the 1980 constitution. 

    On December 17, the people of Chile will decide whether this regressive proposal will become the nation’s constitution. Many questions remain: will the referendum manage to repeat the mass mobilization of voters seen in last year’s constitutional rejection? Or will the results display yet another shift in popular sentiment? In an increasingly polarized country where the far-right dominates the public agenda, Gabriel Boric’s government faces the challenging task of charting the progressive and inclusive economic course for which he was elected. 

  9. Climate Divergence

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    Ten years ago, the current predicament of central bankers would seem unthinkable: to what extent should they contribute to society’s response to climate change? As the impacts of climate change have escalated, most central banks have begun to appreciate the wide-ranging economic and financial consequences relevant to their work. These include the economic damages from heat waves, storms, floods, and droughts, as well as rising sea levels, species extinction, and other environmental shifts. These physical impacts also set the stage for a disruptive societal transformation, which will have consequences for central banks’ ability to maintain monetary and financial stability. How central banks should respond to these new challenges remains hotly contested. What is the appropriate role for institutions with unrivaled power to shift the financial conditions that are critical for a response to climate change, and a complex institutional structure that grants most political independence?

    On each side of the Atlantic, the European Central Bank (ECB) and the Federal Reserve (Fed) have come up with very different answers to this question, as we explore in a new working paper. In a recent speech Frank Elderson, ECB Executive Board member, delivered a call to action: “No transition, or a transition that comes too late, would be the greatest injustice of all. Delay is no solution. Delay is expensive. Delay is disastrous…We can’t allow ourselves to give up. We don’t want to give up. And we won’t give up.” Fed officials, on the other hand, were years later in considering climate change and have had a more conservative approach to their task. Speaking recently, Fed Chair Jerome Powell made the bank’s view clear: “We are not, and will not be, a climate policymaker.” On the international stage, several Eurosystem central banks were among the founding members of the new Network for Greening the Financial System (NGFS), a coalition for central banks and supervisors with an interest in climate and environmental issues that has been highly influential in building and disseminating technical expertise and resources for central banks looking to address these topics. The Fed, on the other hand, abstained from joining until the end of 2020, when there were already eighty-three other members.

    This Fed–ECB divergence is particularly remarkable because of the otherwise dramatic convergence between central banks over the course of the past decades. Since the 1970s, central banks in the West have aligned around three key policy norms. First, that they should focus narrowly on price stability targets via managing interest rates. Second, that they should focus supervision on preventing excessive risk taking. And third, that central banks—independently from political influence—would avoid interfering in credit allocation or industrial policy. Both the ECB and the Fed have centered their climate strategies around risk management through tools like supervisory expectations and climate scenario analysis (or “stress tests”). However, while the Fed has adhered strictly to foundational climate policy norms, unwilling to step in any direction that might be perceived as actively influencing the relative cost or availability of credit, the ECB has instead pursued a proactive reinterpretation of what kinds of instruments and intermediate objectives are permissible to achieve its tasks (see Table 1). This has included the ambition to “gradually decarbonize” the ECB’s corporate bond portfolio, limit the share of high-carbon assets allowed to be pledged as collateral, and grading the quality of bank climate-risk management in determining Pillar 2 capital requirements. These policies are notable because they each have the potential to result in material shifts in the cost of credit for green and carbon-intensive activities.1 In contrast, Fed chair Jermone Powell has said that he “would be very reluctant to see us move in that direction, picking one area as creditworthy and another not.” In our paper, we ask the question: what explains the new climate divergence?

    Table 1:  Three categories of climate-related norms

    Central banks, domestically and internationally

    To understand how central banks act in a given policy area, it’s important to understand their roles both as domestic and international actors. Within the above mentioned policy norms, central banks are insulated from direct political control, and are primarily directed by their legislated mandates. However, despite approaches in the central banking literature that have traditionally accepted these arrangements at face value, the reality is far more complex. Central bank mandates are often vague and include multiple objectives. They cannot speak explicitly to the vast array of circumstances modern central banks may find themselves dealing with, nor tell central banks which trade-offs to make in dealing with those circumstances. At the same time, central banks are subject to legislative oversight and their leaders are appointed by elected officials. As Joseph Stiglitz puts it, “There is no such thing as truly independent institutions. All public institutions are accountable, and the only question is to whom.” This was on full display in the wake of the 2008 Global Financial Crisis, when the Fed had its autonomy to conduct emergency lending programs reined in as part of the Dodd Frank reforms. It was an example of the ways in which domestic political context shapes how central banks undertake their mandated objectives and respond to new policy problems. 

    At the same time, central banks navigate uncertainty by developing norms collectively in transnational governance networks. Despite the fact that central banks operate like delegated agencies domestically, with a narrowly defined basis for legitimacy tied to their political authorities, they are also independently active in processes of global diplomacy, with substantial latitude to engage in agenda-setting in new areas of policy. Central banks regularly cooperate on economic policy, implement global financial legal frameworks, and routinely lend each other billions of dollars. Financial globalization has also created a practical need for international coordination and standardization. The main site for this is the Swiss Bank for International Settlements, in particular its Basel Committee on Banking Supervision, though more recently institutions like the NGFS can be counted among these. Through such networks, central banks develop a shared “logic of appropriateness”2 about both the kinds of problems that they should address and technical knowledge about how to address them. 

    In our paper, we introduce a dynamic norm formation framework to describe the complex interactions over time between central banks’ domestic and international roles that shape central bank processes and narratives. We demonstrate that a favorable domestic political context around climate change set the stage for early action at the ECB, while domestic polarization initially prevented the Fed from addressing climate change. This changed as climate policy norms gained momentum among central banks through international forums like the NGFS.

    Channels of influence

    In Europe, action on climate change, both at the national central banks of the Eurosystem and at the ECB, has come in the context of broad domestic support for such measures. Crucially, central bankers were pushed forward both by legislative initiatives and by activist think tanks and NGOs that encouraged them to examine how climate change impacted their agendas. For example, the earliest articulation of foundational climate norms occurred outside the central banking community, with a 2011 report by NGO Carbon Tracker titled “Unburnable Carbon: Are the world’s financial markets carrying a carbon bubble?” European central banks also received pressure from government officials; the July 2015 Climate and Transition Law in France requested that the Banque de France produce a report on climate risk and climate stress tests. From 2016 onwards, the ECB came under pressure from these same actors to consider climate impact not only in supervision of risk, but also in monetary policy programs. While then-President Mario Draghi and other Governing Council members initially rejected these proposals, domestic politics rendered such a position difficult to maintain. In December 2019, the member states had agreed on the project of a European Green Deal and legally binding climate objectives set out in a European Climate Law. They had also appointed a new ECB president, Christine Lagarde, and several new board members, who initiated a review of the ECB’s monetary policy strategy that examined how to design instruments in light of climate change. These elements prompted the ECB, in turn, to increasingly move toward a more proactive approach. 

    In the US, on the other hand, there was near silence from the kind of domestic actors that turned out to be crucial in the European context. For example, the abovementioned Carbon Tracker report was widely read in the United States, but it did not translate into pressure on supervisors. Bill McKibben, a prominent American environmentalist, was key in amplifying this report in the US. However, he translated it into a campaign for college students to push their universities to divest from fossil fuels. The Fed also faced a highly polarized political environment on climate issues (Figure 2), even under the Obama administration.3 While these dynamics were already present ahead of Trump’s 2016 election, this development decisively froze the agenda. With the withdrawal of the US from the Paris Agreement in 2017, along with hostile domestic climate politics, there was little basis for the Fed to act. 

    Figure 1:  Public opinion on climate change from those who identify with the political left vs right, 2022

    Source: Authors’ graph, data from Pew Research Center 2022.

    However, growing attention to climate change on the international stage became difficult to ignore.  Though the election of President Biden at the end of 2020 substantially eased the domestic context, the Fed had, in fact, begun to devote attention to climate change at the beginning of 2019, while Trump was still in office. As Powell described in 2020, “…we are, you know, very actively, in the early stages of this, getting up to speed, working with our central bank colleagues and other colleagues around the world to try to think about how this can be part of our framework. And we’re watching what other—what other countries are doing.” Nonetheless, the Fed has remained conservative and continues to face a highly polarized domestic political context.

    This is clear when examining the influence of the fossil fuel lobby in Congress.4 In 2022, for example, Sarah Bloom Raskin withdrew her nomination to the Federal Reserve Board over Congressional climate objections, which drew on her earlier comment that regulators should “ask themselves how their existing instruments can be used to incentivize a rapid, orderly, and just transition away from high-emission and biodiversity-destroying investments.” Senator Joe Manchin (D-West Virginia), in opposing her nomination, stated that Raskin had “failed to satisfactorily address my concerns about the critical importance of financing an all-of-the-above energy policy to meet our nation’s critical energy needs.” His political opposition has been linked to the high level of influence of the fossil fuel industry in Congress: Manchin had at that time taken more money from fossil fuel interests than any other senator.5

    It is unlikely this climate divergence will disappear entirely. Polarization on climate policy is deeply ingrained in US politics and the Fed will remain dependent on its government for ongoing autonomy and legitimacy. Now that the Fed is more actively participating in international climate initiatives, both at the NGFS and at the BCBS, a new question emerges: will the Fed act as a conservative force on other central banks’ climate actions? This question is not only relevant for a body like the NGFS, which produces knowledge and sets an agenda for central banks internationally, but will be especially salient for standard setting bodies like the BCBS, where central banks will need to come to a new climate consensus. 

  10. Sectoral Strategy

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    Industrial policy in Africa is back.1 Beginning last January, Nigeria implemented the second phase of its “Sugar Master Plan,” a flagship industrial policy that, since 2013, has sought to stimulate domestic production—predominantly by offering various incentives to investors and by prohibiting refined sugar imports. Last month, Ghana extended a zero VAT policy on locally manufactured textiles, while Kenya announced plans to impose a 25 percent levy on imported clothes to revive its textile sector. This strategic investment is facilitating the country’s transition from merely producing cotton to becoming a significant exporter of textiles. These instances illustrate industrial policy—government strategies designed to promote industrial development or facilitate structural transformation—in action.

    Import substitution industrialization had once been popular in much of Africa, but from the 1980s state intervention models fell out of favor. Governments were advised by the World Bank and the International Monetary Fund to let market forces dictate development paths.2 And so arrived neoliberalism in Africa, largely propelled by structural adjustment programs. Now, with the return of industrial policy on a grand scale, many are questioning whether, as in Europe and the US, neoliberalism may be coming to an end in Africa. 

    Several factors are driving the current resurgence. Key among them is the foreign exchange crisis that has intensified since 2015, leading central banks in many African countries to limit Forex availability for certain imports. This limitation inadvertently prompts domestic manufacture for substitute goods, which then receive support through instruments like credit facilities.3 Elsewhere, China’s Belt and Road Initiative has sparked extensive infrastructure and investment projects. Many African countries have adapted their national strategies to capitalize on Chinese production investments, thereby crafting new industrial policies. The Covid-19 pandemic has further highlighted the importance of this strategic shift, emphasizing the need to cultivate local industries for critical sectors like pharmaceuticals and agro-processing.

    Finally, and perhaps most significantly, is the influence of newly prominent Diversified Business Groups like Nigeria’s Dangote Group. These conglomerates have been steering their national governments toward infant industry protection, import bans, subsidies, tax incentives, and the creation of Special Economic Zones and Industrial Parks. They also promote measures like public procurement and export promotion—quintessential industrial policy measures.

    ​​The revival of industrial policy in Africa coincides with transformative changes in intra-continental trade dynamics, notably the development of the African Continental Free Trade Area (AfCFTA). Although AfCFTA has for the most part been greeted as a positive development in Africa, I argue that it comes with substantial challenges as well. The AfCFTA seeks to encourage industrial policies by promoting the establishment of regional value chains, where different nations specialize in particular production stages.4 But while the agreement is ambitious in many areas, it doesn’t necessarily align with domestic political ambition, which, it must be stressed, may hinder implementation. The coordination involved in organizing various phases of production across the region presents another challenge. I posit that strategic sectoral coordination—achieved through a negotiated division of labor among countries—can serve as an effective strategy to navigate these challenges, providing African nations with a clear pathway to leverage the AfCFTA for industrial development.

    Political realities

    The AfCFTA Agreement establishes a free-trade area uniting all fifty-five African Union member states, encompassing a market of over 1.3 billion people; in terms of the number of countries involved, it forms the largest free-trade area since the establishment of the WTO. The African Union has been pivotal in negotiating the agreement; its origins trace back to 2012 when the African Union Assembly of Heads of State and Government resolved to establish the AfCFTA to enhance intra-African trade. Negotiations commenced in 2015, and the agreement was signed in 2018. The primary aim of the AfCFTA is to forge a unified market for goods and services, underpinned by the free movement of persons to intensify the economic integration of the African continent. More precisely, the State Parties are committed to gradually removing tariffs and non-tariff barriers, liberalizing trade in services progressively, collaborating on investment, intellectual-property rights, and competition policy, engaging in all trade-related areas, cooperating on customs issues, and implementing trade facilitation measures. Furthermore, they agree to establish a dispute settlement mechanism to adjudicate their rights and obligations and to create and sustain an institutional framework for the AfCFTA’s implementation and administration.5

    Though the AfCFTA Agreement officially commenced trading on January 1, 2021, actual trade has not yet occurred, pending the finalization of some protocols. Nevertheless, the AfCFTA has catalyzed the development of key mechanisms: it has established institutional structures that include an Assembly, a Council of Ministers, and a Secretariat headquartered in Accra, Ghana. It has introduced the AfCFTA e-Tariff Book, in line with digitalization and trade facilitation objectives; the Pan-African Payment and Settlement System, created in collaboration with the African Export-Import Bank to streamline intra-AfCFTA payments; an online platform to report non-tariff barriers, which assists in identifying and eliminating trade obstacles across the continent; and the AfCFTA Adjustment Fund, conceived to support countries with the adoption and implementation of the agreement’s stipulations.

    Research on the AfCFTA often overlooks the complex political dynamics within distinct African countries, assuming that complete implementation and compliance are possible when they may in fact not be. For instance, a 2022 World Bank study forecasts that the AfCFTA could boost Africa’s exports by $560 billion, mainly in manufacturing through regional value chains. It could also lift 30 million Africans from extreme poverty, improve the livelihoods of 68 million people earning less than $5.50 a day, and by 2035, increase wages for unskilled workers by 10.3 percent and for skilled workers by 9.8 percent.6

    Additionally, the agreement is projected to raise Africa’s income by $450 billion by 2035, a 7 percent gain, with a $76 billion income boost for the rest of the world. The agreement is expected to yield larger wage gains for women (10.5 percent) compared to men (9.9 percent). However, these projections are based on the assumption of absolute compliance with tariff liberalization and trade facilitation, including the complete removal of red tape and streamlining of customs procedures. Such assumptions fail to acknowledge that the inefficiencies targeted by the AfCFTA are entrenched in the local political landscapes, which often overshadow regional objectives. Consequently, previous regional efforts like the establishment of mechanisms for reporting, monitoring, and eliminating non-tariff barriers have not succeeded due to local political interests.

    For instance, the Republic of Benin depends significantly on an informal entrepôt trade system which thrives on importing goods and informally smuggling them into Nigeria, particularly when Nigeria enacts protectionist policies on products like poultry, used cars, and rice.7 Benin capitalizes on these moments by importing these items in large quantities and smuggling them into Nigeria. Despite its illegality, this trade accounts for roughly 20 percent of Benin’s GDP and holds substantial economic importance for the West African nation’s political elites. For instance, the current president of Benin, Patrice Talon, has a vested interest in this system as his company he owns handles port logistics, which benefits from the entrepôt system and thus a significant revenue stream for the country. Similarly, his main political rival, Sébastien Ajavon, often referred to as the “king of chicken” (due to his dominance in the chicken import market) also benefits from the current system. It is unlikely that political elites would dismantle such a lucrative system essential to their political and economic influence. Similarly, in many African nations, certain non-tariff barriers and inefficiencies are maintained by ruling elites as mechanisms to generate resources critical for their political survival.

    Coordinating regional value chains

    In tandem with the new industrial policies, the AfCFTA is meant to expedite the formation of regional production chains within Africa.8 Yet such production chains, be they global or regional value chains, rarely emerge through market forces alone. They are typically the result of strategic choices and deliberate actions by “lead firms.” These firms hold a central role, coordinating the production chain with authority, determining the particulars of production processes, including task assignments, cost parameters, adherence to standards, meeting specifications, and delivery timelines.9 The absence of lead firms complicates the organization of production; indeed, various coordination failures have surfaced among African nations attempting to foster regional value chains without a central entity to guide the process. To delve deeper into this issue, we must address the essential aspect of the value chain: the organization of production processes. 

    In Africa, the absence of regional lead firms in some sectors has led to coordination failures. For instance, in East Africa, the Kenyan government implemented protective measures against Ugandan raw milk due to Uganda’s cost advantage, despite the fact that Kenya’s dairy processing firms, including confectionery businesses, could benefit from such cost efficiencies.10 Moreover, Kenya has barred maize imports from Uganda and Tanzania, even though maize has a critical role in various production chains like milling, stockfeed production, ethanol, corn starch, and syrup manufacturing.11 Despite the EAC’s commitment to free trade, inter-sectoral complementarity is scant, largely due to the absence of regional lead firms to oversee production organization.

    West Africa presents another example. Nigeria recently enacted a policy to encourage domestic tomato paste production by limiting canned tomato imports and promoting local canning investments. The expectation was that these facilities would utilize tomatoes from both local and regional growers to create a regional value chain. Nonetheless, as Nigeria pursued this policy, other West African countries also sought to develop their tomato processing industries, relying on both local and regional tomato supplies. This led to a notable dilemma: a surge in processing capacity across the region, juxtaposed with a shortage of tomatoes for processing. For instance, a Nigerian investor had to suspend operations of a new facility with a daily capacity of 1,200 tons due to a lack of raw tomatoes—a challenge echoed throughout the region.12 These cases highlight a critical point: the inherent complementarity in production, crucial to regional value chains, does not manifest without concerted coordination and the alignment of national industrial efforts.

    In sectors where African countries have established lead firms, we observe meticulously coordinated regional value chains under their guidance. Telecommunications, one of the most rapidly evolving sectors in Africa, characterized by extensive fintech innovation and significant capital investments, serves as a prime example. Prominent telecom companies possess the capacity to govern their respective chains. The MTN Group, Africa’s premier mobile network operator and the world’s eighth largest, spearheads a supply chain encompassing various facets such as infrastructure, network/IS operations, and commerce. This expansive chain covers over fifty contracted activities, from producing installation materials like network masts and microwave communication dishes to software testing programs and radio planning.13 Given its presence in seventeen countries, each with distinct market dynamics, MTN has found it essential to establish a continental chain. Currently, MTN oversees more than 2,000 critical supply projects, collaborating with over 300 suppliers across Africa, and managing orders valued at billions solely within the continent. While some of these suppliers are opportunistic, others are targeted. Additionally, several regional suppliers also cater to other telecom giants like Safaricom in Kenya and Globalcom in Nigeria. 

    The cement industry offers another instance of lead firms coordinating regional production. Notable entities like Nigeria’s Dangote and Morocco’s CIMAF operate across multiple regions, with each firm overseeing a regional production chain in numerous African countries without any coordination failure. Pioneering lead firms akin to Dangote Cement and MTN emerges as the most pragmatic approach to constructing regional supply chains and actualizing the objectives of the AfCFTA, particularly for chains catering to regional markets.14 However, since African countries possess few lead firms capable of coordinating production, intentional coordination via sectoral negotiations is necessary.

    Sectoral coordination

    It’s unlikely that all African countries will fully implement every provision of the AfCFTA. There is, however, the potential for sector-specific policies within the framework that could support the development of regional value chains. These sector-focused strategies could align with the domestic political landscape, as not all industries are deeply intertwined with local politics in every country. Regional industrial policies should be based on coordination in chosen sectors, as opposed to a comprehensive liberalization that could conflict with various local political climates.

    Sectoral coordination between countries involves the deliberate negotiation of industrial and production policies to address local political challenges and coordination issues that stem from the absence of lead firms. For example, consider the industrial rice value chain. Subject to regional negotiations, it would involve segments like input supply—such as seeds, fertilizers, pesticides, irrigation, and machinery—paddy farming, logistics for collection, and processing activities like milling, grading, sorting, and packaging. Nations facing political challenges in this sector could choose to opt out, or they could leverage their political climate to negotiate a beneficial position, an option less feasible under a comprehensive free trade agreement that is not sector-specific. Such a deliberately negotiated division of labor would perform the role traditionally held by a lead firm by deciding who should produce what. 

    Countries can strategically determine and capitalize on specific niches within a sector based on their unique resource endowments and political landscapes. Consequently, sectoral industrial policies can be precisely tailored and coordinated with the choices of neighboring countries. Continuing with the industrial rice value chain example, a country opting to focus on paddy production must enact paddy-centric policies and cultivate trade networks for collection logistics, or with countries specializing in processing, which should, in turn, develop policies conducive to processing activities. Facilitating negotiations on production processes allows freer trade on the value chain to emerge organically, as opposed to free trade as a prescriptive goal without practical underpinnings. The benefit of a negotiated division of labor is its ability to minimize competitive overlap and foster synergy among nations. This approach can potentially mitigate trade disputes and encourage the development of industrial policies that align with each nation’s designated role in the value chain.

    The AfCFTA and industrial policy

    The weak implementation of free trade policies across the continent, despite stated commitments to the contrary, testifies to the flawed assumptions of the broad liberalization paradigm. While specialization has the potential to harmonize sectoral policies between nations, such coordination requires a reevaluation of the AfCFTA, and in particular, the notion that market forces alone will spur regional value chains. At certain points, two central objectives—implementing domestic industrial policies and expanding trade between African nations—may conflict. While the AfCFTA strives for comprehensive liberalization, sectoral coordination could lead to selective liberalization. Given that the AfCFTA vision of organic, market-led regional value chains may be stifled by the absence of lead firms, sectoral coordination involves a more collective and negotiated approach.

    The AfCFTA presents a unique opportunity for African states to tailor their industrial policies at the sectoral level, rather than implementing blanket liberalization. Opting for selective liberalization and establishing robust regional value chains through a negotiated division of labor could alleviate tensions within the elite networks and policy agendas of distinct counties.  A negotiated division of labor can foster an increase in intra-African trade and provide investment clarity. Achieving this economic transformation in several African nations would consolidate the return of state intervention, while promoting prospects for regional integration.