[House Hearing, 108 Congress]
[From the U.S. Government Publishing Office]
OPENING TRADE IN FINANCIAL
SERVICES--THE CHILE AND
SINGAPORE EXAMPLES
=======================================================================
HEARING
BEFORE THE
SUBCOMMITTEE ON
DOMESTIC AND INTERNATIONAL
MONETARY POLICY, TRADE AND TECHNOLOGY
OF THE
COMMITTEE ON FINANCIAL SERVICES
U.S. HOUSE OF REPRESENTATIVES
ONE HUNDRED EIGHTH CONGRESS
FIRST SESSION
__________
APRIL 1, 2003
__________
Printed for the use of the Committee on Financial Services
Serial No. 108-16
89-081 U.S. GOVERNMENT PRINTING OFFICE
WASHINGTON : 2003
____________________________________________________________________________
For Sale by the Superintendent of Documents, U.S. Government Printing Office
Internet: bookstore.gpr.gov Phone: toll free (866) 512-1800; (202) 512�091800
Fax: (202) 512�092250 Mail: Stop SSOP, Washington, DC 20402�090001
HOUSE COMMITTEE ON FINANCIAL SERVICES
MICHAEL G. OXLEY, Ohio, Chairman
JAMES A. LEACH, Iowa BARNEY FRANK, Massachusetts
DOUG BEREUTER, Nebraska PAUL E. KANJORSKI, Pennsylvania
RICHARD H. BAKER, Louisiana MAXINE WATERS, California
SPENCER BACHUS, Alabama CAROLYN B. MALONEY, New York
MICHAEL N. CASTLE, Delaware LUIS V. GUTIERREZ, Illinois
PETER T. KING, New York NYDIA M. VELAZQUEZ, New York
EDWARD R. ROYCE, California MELVIN L. WATT, North Carolina
FRANK D. LUCAS, Oklahoma GARY L. ACKERMAN, New York
ROBERT W. NEY, Ohio DARLENE HOOLEY, Oregon
SUE W. KELLY, New York, Vice JULIA CARSON, Indiana
Chairman BRAD SHERMAN, California
RON PAUL, Texas GREGORY W. MEEKS, New York
PAUL E. GILLMOR, Ohio BARBARA LEE, California
JIM RYUN, Kansas JAY INSLEE, Washington
STEVEN C. LaTOURETTE, Ohio DENNIS MOORE, Kansas
DONALD A. MANZULLO, Illinois CHARLES A. GONZALEZ, Texas
WALTER B. JONES, Jr., North MICHAEL E. CAPUANO, Massachusetts
Carolina HAROLD E. FORD, Jr., Tennessee
DOUG OSE, California RUBEN HINOJOSA, Texas
JUDY BIGGERT, Illinois KEN LUCAS, Kentucky
MARK GREEN, Wisconsin JOSEPH CROWLEY, New York
PATRICK J. TOOMEY, Pennsylvania WM. LACY CLAY, Missouri
CHRISTOPHER SHAYS, Connecticut STEVE ISRAEL, New York
JOHN B. SHADEGG, Arizona MIKE ROSS, Arkansas
VITO FOSELLA, New York CAROLYN McCARTHY, New York
GARY G. MILLER, California JOE BACA, California
MELISSA A. HART, Pennsylvania JIM MATHESON, Utah
SHELLEY MOORE CAPITO, West Virginia STEPHEN F. LYNCH, Massachusetts
PATRICK J. TIBERI, Ohio BRAD MILLER, North Carolina
MARK R. KENNEDY, Minnesota RAHM EMANUEL, Illinois
TOM FEENEY, Florida DAVID SCOTT, Georgia
JEB HENSARLING, Texas ARTUR DAVIS, Alabama
SCOTT GARRETT, New Jersey
TIM MURPHY, Pennsylvania BERNARD SANDERS, Vermont
GINNY BROWN-WAITE, Florida
J. GRESHAM BARRETT, South Carolina
KATHERINE HARRIS, Florida
RICK RENZI, Arizona
Robert U. Foster, III, Staff Director
Subcommittee on Domestic and International
Monetary Policy, Trade and Technology
PETER T. KING, New York, Chairman
JUDY BIGGERT, Illinois, Vice Chair CAROLYN B. MALONEY, New York
JAMES A. LEACH, Iowa BERNARD SANDERS, Vermont
MICHAEL N. CASTLE, Delaware MELVIN L. WATT, North Carolina
RON PAUL, Texas MAXINE WATERS, California
DONALD A. MANZULLO, Illinois BARBARA LEE, California
DOUG OSE, California PAUL E. KANJORSKI, Pennsylvania
JOHN B. SHADEGG, Arizona BRAD SHERMAN, California
MARK R. KENNEDY, Minnesota DARLENE HOOLEY, Oregon
TOM FEENEY, Florida LUIS V. GUTIERREZ, Illinois
JEB HENSARLING, Texas NYDIA M. VELAZQUEZ, New York
TIM MURPHY, Pennsylvania JOE BACA, California
J. GRESHAM BARRETT, South Carolina RAHM EMANUEL, Illinois
KATHERINE HARRIS, Florida
C O N T E N T S
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Page
Hearing held on:
April 1, 2003................................................ 1
Appendix
April 1, 2003................................................ 47
WITNESSES
Tuesday, April 1, 2003
Bhagwati, Jagdish, Andre Meyer Senior Fellow in International
Economics, Council on Foreign Relations........................ 25
DeRosa, David, President, DeRosa Research and Trading Inc........ 28
Henry, Peter Blair, Associate Professor of Economics, Stanford
University Graduate School of Business......................... 29
Lackritz, Marc E., President, Securities Industry Association.... 31
Mendenhall, James E., Assistant U.S. Trade Representative for
Services, Intellectual Property, and Investment................ 8
Tarullo, Daniel, Professor of Law, Georgetown University Law
School......................................................... 33
Taylor, Hon. John B., Under Secretary, Department of the Treasury
for International Affairs...................................... 6
Vastin, J. Robert, President, Coalition of Services Industries... 34
APPENDIX
Prepared statements:
Oxley, Hon. Michael G........................................ 48
Sanders, Hon. Bernard........................................ 49
Bhagwati, Jagdish............................................ 51
DeRosa, David (with attachments)............................. 64
Henry, Peter Blair........................................... 151
Lackritz, Marc E............................................. 161
Mendenhall, James E.......................................... 172
Tarullo, Daniel.............................................. 177
Taylor, Hon. John B.......................................... 193
Vastine, J. Robert........................................... 198
Additional Material Submitted for the Record
Frank, Hon. Barney:
Center for Global Development, prepared statement............ 208
Columbia Business school, prepared statement................. 210
Investment Company Institute, prepared statement............. 215
OPENING TRADE IN FINANCIAL
SERVICES--THE CHILE AND
SINGAPORE EXAMPLES
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Tuesday, April 1, 2003
U.S. House of Representatives,
Subcommittee on Domestic and International
Monetary Policy, Trade and Technology
Committee on Financial Services,
Washington, D.C.
The subcommittee met, pursuant to call, at 10:01 a.m., in
Room 2128, Rayburn House Office Building, Hon. Peter T. King
[chairman of the subcommittee] presiding.
Present: Representatives King, Biggert, Manzullo, Ose,
Feeney, Hensarling, Murphy, Barrett, Harris, Maloney, Sanders,
Sherman, Hooley, Velazquez and Frank (ex-officio).
Chairman King. [Presiding.] The hearing will come to order.
I welcome all of you here today.
Today, the Domestic and International Monetary Policy,
Trade and Technology Subcommittee meets to discuss the
financial services-related aspects of the recently announced
free trade agreements. While the issue of trade is generally
the ambit of other committees, this subcommittee is
specifically responsible for international investment policies,
both as they relate to U.S. investments for trade purposes by
citizens of the U.S., and investments made by all foreign
entities in the United States. This also includes trade as it
relates to the U.S. financial sector as a key service industry.
Today, the subcommittee examines the recently concluded
free trade agreements with Chile and Singapore. The United
States reached agreement with these allies on December 10, 2002
and January 15, 2003 respectively. Many have suggested these
agreements will help provide a framework going forward from
which the United States can negotiate with other countries and
regions. Specific to financial services, these agreements will
provide much-needed certainty and transparency to allow U.S.
investment to operate with confidence in these expanding global
markets. National treatment, capital controls, transparency of
financial regulation and efficient administrative review are
just some of the many complex issues that U.S. negotiators have
addressed in coming to resolution on these specific FTAs. I
commend Ambassador Zoellick and his team at USTR and the
Treasury for the work they have done on behalf of the working
men and women of this country. As a supporter of U.S. free
trade, I look forward to working with the administration to
ensure implementation of these agreements.
I recognize that with any negotiated agreement that there
will be some who disagree with its provisions. While we can
agree to disagree, I hope that if there is discussion on these
disagreements, it will be based on facts and conclusive
evidence. Today, we have a strong two-panel group of witnesses
ranging from administration officials to academia to the
private sector. I look forward to a lively debate on the merits
of these trade agreements and would remind members that as the
Financial Services Committee, we would greatly appreciate that
the topic of discussion remain focused on financial service
trade issues.
I now recognize my New York colleague and ranking member,
Mrs. Maloney, for opening statements.
Mrs. Maloney. Thank you, Mr. Chairman, for granting this
hearing, and thank you especially, Ranking Member Frank, for
working to include this topic in the subcommittee's agenda. I
know it is an area that you have great expertise and have done
a great deal of work.
As the lone world superpower and with U.S. forces engaged
militarily around the world, the importance of using U.S.
economic strength to spread American values gains heightened
importance. Through promotion of rules-based fair trade
policies, the U.S. has had an opportunity to lead the
international community for the benefit of both rich and poor
countries, while at the same time increasing opportunities for
U.S. businesses and workers. By and large, the bilateral trade
agreements between the U.S. and Chile and the U.S. and
Singapore advance this effort. Both agreements knock down
restrictions on domestic markets that serve to increase in
efficiency and punish consumers who often pay the cost of
protectionist policies. In financial services, these bilateral
agreements offer U.S. companies exciting new opportunities in
areas as diverse as excess to ATM networks, to increased
opportunities to compete in new insurance markets.
Given the many positives in these agreements, it is
disappointing that our trade negotiators held out for a
controversial position on capital controls that seeks special
protection for U.S. investors. The trade agreements contain
investor-state dispute settlement procedures that determine how
U.S. investors can win damages if Chile or Singapore violate
the free transfer provisions in each agreement. Reports
indicate that these protections for U.S. investors were
included at the urging of the Treasury Department, and that
these negotiations over these provisions were some of the most
contentious areas in the negotiations. Effectively, these
provisions allow U.S. investors to seek damages in the event
that Chile or Singapore take measures to limit capital flight
in the event of a reoccurrence of an Asian financial crisis-
like emergency. While Chile and Singapore are unlikely to need
to impose capital controls, many economists have expressed the
concern that the administration will insist on these provisions
as a template in future trade negotiations with less stable
countries.
Such a policy could lead to a situation where wealthy U.S.
bondholders have legal claims against a country that has
imposed capital controls, while all other investors face losses
and where the country's own people are suffering through an
economic collapse. This special status for U.S. investors sends
the wrong message about promoting free trade and could increase
anti-American feelings. Critics of this policy have said its
effects are to protect a special class of capitalist, rather
than to promote stable capital markets.
In addition to the fairness argument, many economists
including some at the IMF increasingly believe that the
imposition of limited capital controls can be an effective
means of stemming the flight of hot money. In the short term,
capital controls can increase stability and reassure investors
that economies are not prone to sudden collapse. I note that
the witnesses who will express concern about capital controls
in their testimony today are otherwise staunch free traders. I
think this lends credence to the argument that at the very
least, the effectiveness of capital controls is open to debate
and the rigidity of the administration's position is a concern
of many mainstream trade supporters and economists.
I yield back my time.
Chairman King. Mrs. Biggert, any opening statements on this
side? I recognize the ranking member of the full committee, Mr.
Frank.
Mr. Frank. Thank you, Mr. Chairman.
Let me pick up from where the ranking member of the
subcommittee left off with her excellent statement. What is
striking to me is the number of leading advocates of increased
trade who are critical of this inclusion of capital
restrictions. We will have a very distinguished economist,
Professor Bhagwati; we will have Mr. Tarullo, who helped in the
Clinton administration push forward with trade agreements, some
of which I did not agree with.
I want now at this point to enter into the record a
statement, first from Nancy Birdsall, who is president of the
Center for Global Development, a strong supporter of free
trade.
[The following information can be found on page 208 in the
appendix.]
Chairman King. Without objection.
Mr. Frank. I appreciate that.
Secondly, I want to read excerpts from it. I will include
statements from Joseph Stiglitz. I must say Professor Stiglitz
and Professor Bhatwati are two of the acknowledged experts
internationally in support of sensible liberalized trade and a
globalization that will take us where we ought to go. It is
impressive to me that both of them are quite critical of this
particular inclusion of restrictions on capital controls. I
will now read Mr. Stiglitz's statement. ``The importance of the
subject of these hearings cannot be overestimated.''
Let me say that he was not able to come because of
scheduling problems.
``The provisions of the recent trade agreements with Chile
and Singapore limiting government interventions in short-term
capital flows are a major source of concern. Everything should
be done to eliminate them from the agreements and to make sure
that such provisions are not inserted into future trade
agreements. Reducing trade barriers can be of benefit to all
parties. Problems are encountered, however, when trade
agreements go beyond trade issues, as in this case, forcing
countries to undertake measures which should be a matter of
national sovereignty. Such provisions have earned trade
agreements a reputation for undermining democracy, and I
believe that sometimes these accusations are deserved.
``It is of salient concern with a particular provision that
risks imposing considerable harm on the country. Much of the
instability in global financial markets in recent years,
especially in the emerging markets, has been related to short-
term capital flows. Capital rushes into a country and just as
quickly rushes out, leaving havoc in its wake. The crises in
East Asia were largely caused by premature capital market
liberalization. The volatility is particularly hard on the poor
and serves to create poverty. It is the low-skilled workers who
bear the brunt of recessions and depressions. Chile, in its
period of rapid economic growth in the early 1990s, imposed
restrictions on the in-flow of capital. I believe such
restrictions played an important role in its growth and
stability.
``By the same token, developing countries in Asia that have
grown the fastest, done the most to eliminate poverty and
exhibit the greatest stability, have all intervened actively in
capital markets at critical stages in their development, and
many continue to do so today.
``Let me be clear, while there were financial interests in
the United States that might benefit from forcing countries to
open up to the short-term capital flows, and there are even
some who have benefited from the resulting economic chaos by
buying assets at fire-sale prices only to re-sell them at great
profit when economic calm has been restored, forcing countries
to open up their markets to these short-term capital flows is
not in the interests of the United States. It is in our
interest to have a more stable global economy. It is in the
interest of businesses that are investing abroad that there be
greater economic stability.
``Yet economic research has identified short-term capital
market liberalization as the single most important factor
contributing to the instability in Asia and Latin America.
Today, there is a growing consensus among economists against
liberalizing capital markets for short-term capital flows for
most emerging countries. Even the IMF has recognized this. The
extent and form of capital market liberalization is a matter
which should be left for each country to decide through
democratic processes.
``We can encourage a full democratic debate on these issues
with a public discussion of experts in developed and developing
countries, debating the advantages and disadvantages. But we
should not be using our economic power and the promise of
increased investment and exports to impose the viewpoint of a
particular set of interests or a particular ideology on our
trading partners.
``The arguments for trade liberalization are totally
distinct from those for capital market liberalization. They
share in common but one word--liberalization. There is an
emerging consensus among economists that emerging markets
should be particularly wary about full capital account
liberalization. It makes little sense for our trade agreements
to be pushing on our trading partners restrictions which fly in
the face of sound economics.''
Let me just reiterate, it is clear we in this case imposed
on both Chile and Singapore over their initial objections and
their continuing objections this particular addition to free
trade. I think that it is very important to understand, I would
hope that we would move toward a consensus on freer trade,
globalization, taking into account other values. This inclusion
of a very rigid particular ideological view using America's
power to impose these in individual free trade agreements goes
exactly in the opposite direction.
Chairman King. Thank you, Mr. Frank. I would ask if any
other members have an opening statements, that they submit them
in writing so we can get to the statements of our witnesses.
Mr. Sanders?
Mr. Sanders. Thank you very much, Mr. Chairman.
This is an important hearing. It is an important hearing
because it raises discussion about our trade policy. It is
important to begin to talk truth about our trade policy and
recognize that from beginning to end our trade policy has been
an outrageous failure. And it is incomprehensible to me that
people keep coming forward--we had Alan Greenspan in front of
the full committee a couple of months ago talking about the
ongoing success of our trade policy. I wonder. I scratch my
head and I say, what world are these people living in?
If our trade policy is such a success, Mr. Chairman, why do
we have a $400 billion trade deficit? Why in the last two
years, and let me reiterate this, because it is not talked
about too often by all the editorial writers who support free
trade, how come in the last two years on our ongoing success of
free trade, we have lost close to two million manufacturing
jobs--10 percent of our manufacturing workforce? How come 20 or
30 years ago, General Motors used to be the largest employer in
America where workers earned a decent wage?
And Mr. Chairman, you know who the largest employer in
America today is? It is Wal-Mart, where large numbers of people
are on food stamps. How come any concrete examination of NAFTA
will tell us that it has been a disaster for the people of
Mexico, for the middle class, the poor people of Mexico, as it
has been a disaster for working people in this country?
I returned from China a month ago. It is not just that we
have a $100 billion trade deficit with China. If anybody thinks
that all the Chinese are going to be doing is stuffing teddy
bears and making sneakers, you are absolutely mistaken. All of
the evidence is there. It is not just blue collar jobs that are
going to be replaced. It is white collar jobs and that is
taking place right now. All of the evidence is there.
Mr. Chairman, I have a long statement which I would like to
submit for the record. But I think that extending our trade
policy should be laughed out of the Congress. We should be
saying, are you serious? Obviously, you are joking, aren't you,
coming here asking us to extend a disastrous trade policy. You
are not really serious? We all have a good sense of humor. But
to tell us to extend a disastrous trade policy which is causing
havoc not only for the middle class, the working class of this
country, but for poor people all over the world. Tell us about
what is going on in Latin America--Venezuela, Argentina, the
huge uprisings, mass demonstrations against the IMF, against
these trade policies.
Now, obviously we understand what goes on in American
politics. Large corporations flood this building with huge
contributions. Yes, I admit it. Trade policy works well for
those companies that want to throw American workers out on the
street and hire poor people for pennies an hour. Yes, I grant
you. It works well for those CEOs that make a few hundred
million dollars when they retire. But for the poor people of
the developing world and for the middle class of this country,
it is a failure, and the idea that we are thinking of extending
our trade policies should be laughed out of this office.
I would ask unanimous consent to allow my statement to be
submitted for the record.
Chairman King. The gentleman's time has expired. Without
objection, his full statement will be made part of the record.
[The prepared statement of Hon. Bernard Sanders can be
found on page 49 in the appendix.]
With that, we will go to our first panel today--the
Honorable John B. Taylor, Under Secretary of Treasury for
International Affairs, and Mr. James Mendenhall, Assistant U.S.
Trade Representative for Services for Investment and
Intellectual Property. We will begin with Mr. Taylor.
STATEMENT OF HON. JOHN B. TAYLOR, UNDER SECRETARY OF TREASURY
FOR INTERNATIONAL AFFAIRS
Mr. Taylor. Thank you very much, Mr. Chairman, and Ranking
Member Maloney for calling this hearing and inviting us to
testify. I would like my oral remarks to just summarize briefly
the written testimony and submit the written testimony to the
record.
Chairman King. Without objection, your full statement will
be made part of the record.
Mr. Taylor. I would like to focus in my oral remarks on
provisions related to trade in financial services and to
investment in capital transfers in the free trade agreements
with Chile and Singapore. Let me focus first on trade in
financial services.
We believe that reducing barriers to trade in financial
services is an essential part of a good trade policy which aims
to reduce barriers of all kinds to trade. Open financial
sectors lead to more growth. They lead to a better allocation
of savings. They lead to better services for people who take
advantage of the better financial services. There is a
reduction in the barriers to trade in financial services that
is part of the two free trade agreements that we are discussing
today. For example with respect to Singapore, Singapore has
agreed as a matter of opening its market to financial services,
to lift the ban it has had on new licenses for banks to operate
in Singapore. It has also allowed for banks to get access to
additional ATMs that are run by local banks. And it has reduced
the limits to the number of ATMs that banks can have. So you
can just see by these examples that these are the kind of
things that improve the financial services that are available
to people in Singapore, and at the same time bring business
opportunities to U.S. firms.
With respect to Chile, Chile has agreed that it would make
prior notice to any regulatory changes that might have bearing
and implications for financial service firms. It is also
providing more access to financial advisers and financial
management firms who want to take a role in the management of
the Social Security accounts in Chile. These are just some
examples of the specific things that U.S. firms and consumers
in Singapore and Chile can benefit from from reducing the
barriers in financial services. On top of all those, as a
chapeau, is an agreement that there would be a lock-in, a
commitment not to remove these commitments, not to increase the
barriers their current levels, so that there is no going back
from the position where the countries are with respect to
financial services.
Let me now briefly talk about the investment in capital
transfers part of the agreements. Reducing barriers to the flow
of foreign investment is also an essential for raising economic
growth and reducing poverty in countries around the world. More
capital means there is more capital for workers to use to
produce, to raise their productivity. Access to capital is an
essential way to reduce poverty by raising productivity. One of
our major objectives in this administration is to reduce
barriers to the flow of capital to emerging markets in
developing countries in general, and thereby having greater
productivity and lower interest rates as well. I just might
mentioned as an aside that the president's proposal for
Millennium Challenge Accounts, which is aimed at the very
poorest countries in the world, has as a feature a way that
their policies will be ones that attract foreign investment and
attract capital so that again productivity can increase and
poverty can be reduced.
Another example of how our policy is aimed to improve
foreign investment around the world is our long-term BIT
policies, the bilateral investment treaties, which have been
underway for the last 20 years. These bilateral investment
treaties are an effort to make the policies in the countries
more welcoming to foreign investment so that the countries
themselves can benefit from it, as well as the foreign
investors.
Now, our FTAs with Singapore and with Chile have endeavored
to stick with this policy of free transfers that exists in our
bilateral investment treaties. I would say that all sides to
these agreements with respect to the Chile, the Chileans and
the Americans, with respect to Singapore, the Singaporeans and
the Americans--they have agreed that there is an importance to
have this free transfer of capital. They agree that
restrictions on transfers would clearly not be consistent with
the goal of encouraging investment to raise productivity and
reduce poverty.
As with the rest of the free trade agreement, there is a
dispute settlement mechanism that we put in place. It comes
into play when there is a restriction placed on goods trade,
service trade, or on capital transfers. The dispute settlement
mechanism that we negotiated with respect to capital transfers
we think makes a lot of sense and it is one that both the
Chileans and the Singaporeans are happy with, as we are. In the
case of restrictions on capital, there is a cooling off period
before a dispute settlement mechanism comes into place. For
foreign direct investment type of investment, the cooling off
period is for six months before action can be taken. For other
types of restrictions, the cooling off period is for 12
months--other types of restrictions on shorter-term capital
movements--direct loans. So there is a longer cooling off
period for the types of capital transactions and capital flows,
capital transfers that several of you have already raised in
your opening remarks.
We think this dispute settlement mechanism builds on
current practice, but allows for a compromise for different
views about how capital markets work. We think it is a good
place to have the subject of transfers dealt with in
agreements. It is a novel approach and we think it works quite
well.
Let me just summarize after giving these specifics. We
think that the approach undertaken in these FTAs is consistent
with a shared economic philosophy and policy perspective of all
three countries that we are talking about--the United States,
Chile and Singapore. The inclusion of these free transfer
provisions, as I have just described it, in the Chilean and
Singaporean FTAs with the United States we think sends a strong
signal to the markets that all these countries support the free
flow of capital and they recognize its importance to the
development and growth of economies. Without a doubt, these
agreements represent a win-win situation for all the countries
involved.
I would like to thank you very much, Mr. Chairman, and to
your colleagues, for the opportunity to testify here and look
forward to a discussion of these issues.
Thank you.
[The prepared statement of Hon. John B. Taylor can be found
on page 193 in the appendix.]
Chairman King. Thank you, Secretary Taylor.
Mr. Mendenhall?
STATEMENT OF JAMES E. MENDENHALL, ASSISTANT U.S. TRADE
REPRESENTATIVE FOR SERVICES, INVESTMENT AND INTELLECTUAL
PROPERTY
Mr. Mendenhall. Good morning, Mr. Chairman, Ranking Member
Maloney and Mr. Frank and other members of the committee. I
appreciate this opportunity to come before you today to testify
on the financial services chapters in the Chile and Singapore
free trade agreements. I particularly look forward to this
discussion because I am newly appointed in my current position
as assistant U.S. Trade Representative and this is my first
opportunity to discuss these issues with you.
Since the passage of the Trade Act of 2002, we have pursued
an aggressive trade agenda. As stated by Ambassador Zoellick,
we are proceeding with trade initiatives globally, regionally
and with individual nations. This strategy creates a
competition in liberalization, with the United States at the
center of a network of initiatives. The recently completed
agreements with Singapore and Chile represent the first of the
next generation of trade agreements. We have also launched FTA
negotiations with five other countries or regions, and at the
same time the free trade are of the Americas negotiations are
ongoing and are set for completion by January of 2005. On the
multilateral front, just yesterday the United States submitted
its initial offer in the current round of services negotiations
in the WTO.
For several reasons, Chile and Singapore provided a good
point of departure. First, the United States has a growing and
significant economic interest in trade with these countries.
Second, specifically with respect to financial services,
Singapore and Chile have taken steps to open their financial
sectors. Both countries respect the concept of the rule of law
and were in a good position to explore market access-enhancing
concepts relating to transparency of regulatory structures.
They have already committed to moving in the right direction
for many sectors and our FTAs will reinforce these trends.
Finally, the Chile and Singapore FTAs provide good toe-
holds for expanding liberalization in South America and Asia
respectively. The liberalization of financial services was one
of our main objectives in negotiating the Chile and Singapore
FTAs. In the final texts, we achieved the objective set forth
in TPA to eliminate discriminatory and other types of
restrictive measures on the supply of services. The United
States already enjoys a significant competitive advantage in
financial services in international markets, and the market-
opening initiatives in the Chile and Singapore FTA and in other
for a should create additional opportunities for our financial
services suppliers. Opening foreign markets for exports of U.S.
financial services has two added advantages. First, it creates
jobs and expands economic opportunities. For example, states
like New York, California, Florida, Illinois, Massachusetts and
Pennsylvania depend on financial service activity to contribute
to their economic growth and tax base. Also by expanding access
to financial services, it enhances prospects for economic
growth at home and abroad.
Second, the opening of foreign markets for financial
services creates export opportunities for other sectors. For
example, financial services companies rely heavily on
specialized software and data processing, thereby creating
increased demand for computer-related services which is another
strong point of the U.S. export picture. And as countries
develop their economies with the help of foreign financial
services, those countries consume a wider range of goods and
services, which benefits U.S. exporters more generally.
The financial services chapters in the Chile and Singapore
FTAs cover all means of supply that are relevant for financial
services trade, and include a set of important core
protections. The agreements require national and most-favored-
nation treatment, which ensures that U.S. financial service
suppliers are treated on equal terms with their foreign
competitors. They also include a market access obligation to
ensure that measures such as quantitative restrictions and
requirements regarding forms of legal entities do not undermine
general market access rights. Lack of transparency is also a
major problem facing our financial service suppliers, and we
have included provisions that directly address this more
subtle, but equally insidious market access barrier. In
addition, we have provided rights for foreign-owned
institutions to introduce new financial services when certain
conditions are met.
Finally, I would like to say a word on the issue of capital
controls. The issue of capital controls is clearly complex, yet
we have to recognize the potentially serious negative impact
capital controls could have on U.S. investors. Our FTAs contain
safeguards to allow American investors to have access to their
funds, while at the same time they grant Chile and Singapore
the flexibility to manage capital flows.
The Chile and Singapore FTAs mark a significant advance
over commitments in other fora. For example, unlike in some
other agreements, our Chile and Singapore FTAs adopt a
presumption that national treatment will apply unless a
specific sector is carved out. Chile and Singapore have agreed
to commitments across a wide array of financial services that
exceed the level of the current GATT's commitments. In some
cases, they have undertaken commitments to preserve existing
levels of openness that go beyond their GATT commitments, while
in other cases they have agreed to commitments that go beyond
the current practice. We would be pleased to discuss specific
commitments with you here today or to meet separately with you
and your staff to discuss in further detail.
While we have moved aggressively to open foreign markets,
we are sensitive to the careful balance struck through our own
political and legal processes between regulatory and commercial
interests. In fact, while the United States agreed to a high
level of access under the Singapore and Chile FTAs,
implementation of the financial services chapters in the FTAs
will not require any changes to U.S. law or practice.
We can expect real benefits to accrue to the U.S. economy
as a result of the Chile and Singapore agreements. As we
advance a strong trade promotion agenda, we remain ever-mindful
of the objectives Congress asked us to achieve when it granted
trade promotion authority. I look forward to working with you
and your staffs in the future as we strive to continue opening
markets around the world. I thank you for the opportunity to
testify here today.
[The prepared statement of James E. Mendenhall can be found
on page 172 in the appendix.]
Chairman King. Thank you, Mr. Mendenhall.
As you can determine from some of the opening statements,
there is a concern, I believe, by certain members of the
committee and certain members in the Congress that in certain
elements of the negotiations the United States may have used
coercion or improper pressure to cause Singapore and Chile to
agree to, or to make certain concessions they would not have
made otherwise, specifically in the area of capital controls.
If you could address that to the extent you can, how the give
and take went, and why you feel that this is essential as far
as capital controls.
Mr. Taylor. I would say the give and take was healthy and
candid, like any other negotiation that I have been involved
with. The issues are very complex, as Mr. Mendenhall indicated.
There are different points of views. But I think what was most
often emphasized to us is that the free transfers of capital is
important by Singapore and by Chile. They have those policies
in place right now. Neither country has capital controls in
place. We were working with them. In fact, many of the ideas
that are in this were mutually reached in the discussions. So I
would say that they were good. They were healthy. Some of them
took place in Singapore. Some of them took place in the United
States. They were part of a larger trade agreement, to be sure,
in which there were many issues being discussed. Financial
services and some of the others we discussed here, but there is
trade in goods as well.
Chairman King. Mr. Mendenhall, do you have anything to add
to that?
Mr. Mendenhall. I agree with everything that Under
Secretary Taylor just said. I think in the give and take of
these negotiations, it is just that--a give and take. However
much we may like to lay down the law on a particular point and
force our trading partners to accept it, it is a negotiation.
In fact, I believe where we ended up with on capital controls
was the result of a negotiation. It was not the result of the
United States imposing its will in any way, although Under
Secretary Taylor would know this more than I would on that
particular issue. I believe that was the case here.
Chairman King. Secretary Taylor, in your testimony you
discuss the president's MCA initiative. Can you go into more
detail on that as to how you believe the requirements of the
MCA will make this country more attractive to investors?
Mr. Taylor. Mr. Chairman, the Millennium Challenge Account
is a program which is designed for which funds will go to
countries that are following policies that are conducive to
economic growth. Many of those same policies are conducive to
foreign investment. So for example, there are the three
categories of policies--ruling justly, investing in people, and
encouraging economic freedom. In the ruling justly part of the
policies, there is an emphasis on the rule of law so for
example, foreign investors know the rules of the game before
coming into a country. It is a very important part of the
Millennium Challenge Account--the rule of law. In the
encouraging economic freedom section, there is a commitment to
have a low inflation rate, a stable macroeconomic environment,
which is also conducive to foreign investment. It creates
greater certainty. In the investing in people part of the
Millennium Challenge Account, it is a commitment for countries
to invest in their people, in education and health. So
obviously, a good well-educated workforce is one of the best
ways that foreign investment can be productive in a country.
So just for example, as you know, some foreign investment
in Africa has taken advantage of countries where the skill
level is rising. In Ghana for example, education is improving
and we see U.S. firms and other firms going in to take
advantage of that for computer work, for call centers. Those
are the kind of foreign investments that can actually improve
well-being in the country directly. The Millennium Challenge
Account encourages that through the policies that I indicated.
Chairman King. Mr. Mendenhall, do you have anything to add
to that?
Mr. Mendenhall. No, I agree.
Chairman King. Mrs. Maloney?
Mrs. Maloney. Thank you for your testimony. Secretary
Taylor and Mr. Mendenhall, in future trade agreements and
negotiations, what will be the position on capital controls? Is
the language in the Chile and Singapore agreements an example
for future negotiations? Is this something we are going to
continue or is this just for these two very strong economies,
Chile and Singapore?
Mr. Taylor. I think the strategy of focusing on dispute
resolution is one that we have found attractive in dealing with
these negotiations, and we would like to see how that works
with respect to other countries.
Mrs. Maloney. So do you plan to use this in other trade
agreements? That is what I want to know.
Mr. Taylor. Yes, I think the dispute resolution mechanism
is a good way to handle this. It is very attractive to both
Chile and Singapore, but the specifics will differ by country.
I gave the example of the six-month and twelve-month--maybe
those numbers would change. I gave examples of what kind of
foreign direct investment type of investments at the six-month.
Maybe that would change. But I would say it would depend on
what the country wants to do. The country is negotiating with
us. They have their own interests and their own desires. We
think this general approach works well, and would like to try
it out as we go, but it is flexible. It is one of the good
advantages of it, it is flexible. And it does have this
constant ability for us to emphasize the importance of foreign
investment and free transfers and not putting restrictions on
capital, at least trying to stay away from that as much as
possible. That is a philosophy that is embedded in the
approach.
Mrs. Maloney. Secretary Taylor, your testimony reads, and I
quote, ``our position is to seek greater protection for U.S.
investors than the IMF articles of agreement and the GATTs
afford,'' end quote. If this language is included in trade
agreements with countries that are more prone to economic
collapse than Chile and Singapore, are you concerned about the
international fall-out in a situation where U.S. investors win
compensation, while all other foreign investors face losses and
while a suffering country's own people are experiencing an
economic collapse?
Mr. Taylor. The comparison with the GATTs is important. The
way I think about it, an FTA, a free trade agreement, is an
effort to get a reduction in barriers compared to what you
would have if you did not have a free trade agreement. It is an
opportunity for both countries to reduce barriers compared to
what would exist out there under the GATTs or under other
multilateral trade agreements. So it is natural that the
barriers are less in a free trade agreement and that is what
you are seeing here. With respect to other countries, as we go
forward, I just go back to my previous answer that it will
depend on the country's situations and what they really would
like. We have noted in just going over our BITs and reviewing
all the BITs we have had, that there are many very poor
countries who welcome the opportunity to pledge to make it
clear in an agreement that they were very welcome to foreign
investment and very open. My best guess is other countries are
going to do that as we do more BITs and as we do more FTAs, but
it very much depends on the countries and the negotiations.
Mrs. Maloney. I want to follow up on if we go into these
trade agreements and U.S. investors are able to recover for
losses caused by imposing the capital controls, won't foreign
investors learn to channel their own investments through U.S.
investment banks, so that they would get the protection of the
U.S. trade agreements? It is not going to be long that they are
going to see if I put my money in, I cannot get it out; if I go
through the U.S., I will be able to get my money out. Does that
increase efficiency? What would the impact of that be? If I
were a foreign investor, I would immediately start going
through U.S. banks to make sure I could have the same treatment
that U.S. investors have.
Mr. Taylor. I think that is an observation which is
important. I think that if you recognize the dispute settlement
mechanism that we are using here in the free transfers is
similar to dispute resolutions that occur in other places. For
example, it is called investor state, and investor-state gives
the opportunity for individuals to take action in an agreement
like this.
Mrs. Maloney. I was not aware other countries had the same
language. I thought we were unique in that respect.
Mr. Taylor. What I was going to say is it occurs in other
trade agreements. I have not observed any particular phenomenon
that you are mentioning in our other agreements. In a way what
we have done in the capital area here is lengthen the cooling
off period from what it was otherwise, because the six-month
cooling off period in other agreements I do not know exactly
the time in the BITs, but there is always a cooling off period
of some kind; there is always and investor-state dispute
resolution mechanism in all of our bilateral investment
treaties, and in NAFTA.
Mrs. Maloney. But Mr. Secretary, even after a year couldn't
they face the same problems with the economic collapse of their
own people, other investors not being able to get their money
out? Even after a year, you would still have the same elements
that could be problematic, wouldn't you?
Mr. Taylor. The year gives it more time to sort things out,
and it is a substantial period with respect to any of the
desires or any of the requests that I have ever seen that the
countries would like to put on controls like this. So that
leeway seemed very acceptable to both Chile and Singapore, and
I believe to other countries as well. Remember, neither
Singapore nor Chile are using these controls right now.
Mrs. Maloney. My time is up. Thank you for your testimony.
Chairman King. Mrs. Biggert, the vice-chair of the
subcommittee.
Mrs. Biggert. Thank you, Mr. Chairman.
The Asian financial crisis has been cited here and it is
often cited by proponents of capital restrictions as a reason
why developing countries should be able to limit the movement
of capital within their borders. But wasn't the Asian crisis
the result of a weak banking system and cronyism and
ineffectual regulation? With increased trade in financial
services and greater regulatory transparency, will countries
that were once vulnerable to currency crises be stronger and be
able to withstand economic downturns?
Mr. Taylor. Yes, I agree with that very much. What we have
seen when investment is open to foreign companies or financial
services firms, it frequently brings in better prudential
regulations. With respect to the first part of your question,
yes I very much agree that a lot of the crisis had to do with
currency mismatches, where liabilities and assets did not match
by currency, and that was because of defective regulations in
many cases. So that can be improved and I think the foreign
investment and the experience of financial service firms in the
United States and other developed economies can be very
helpful.
Mrs. Biggert. And then going back to the short-term
restriction on the transfer of capital which was put in for
Chile and Singapore, can you give the committee any examples of
where capital restrictions were responsible for preventing a
crisis or promoting growth?
Mr. Taylor. No, I cannot personally give you examples, but
looking at the many examples where capital controls have been
applied, sometimes they change the maturity structure of debt,
maybe more longer term, less short term. There is evidence for
that in Chile. That has not, in my view, had an impact on
crises. But it has also had disadvantages. There are some
recent studies that show that those same controls made it more
difficult for small firms to get credit, to get access to
markets. So it had a bias against small firms in the country.
So often these kinds of controls have impacts that you do not
even know about when you are putting them on. There are always
disadvantages, even studies that try to find and look for the
benefits of a capital control, that it really was effective in
stemming a crisis or in remedying a crisis. As I read the data,
I do not see them used effectively that way. But even when they
are used, you see the other harmful effects that come from
them.
Mrs. Biggert. Our U.S. financial service products are some
of the most effective and most sophisticated in the world. How
will increases in trade in financial services result in greater
economic stability in these countries and what impact will
greater access to capital have on Chile and Singapore? Maybe
Mr. Mendenhall can answer that.
Mr. Mendenhall. I will have to leave it to Under Secretary
Taylor to talk about the specific economics of it. But I think
there are several studies out there available, the most recent
on coming out of the University of Michigan talking generally
about the liberalization of trade in goods and the benefits for
developing and developed countries alike. I apologize I do not
have specifics for Chile and Singapore, but this particular
study for example said that just for the United States that for
services alone, a one-third cut in services restrictions would
result in a gain for the United States of $150 billion. I think
there are studies out there supporting, maybe not of the same
magnitude, but supporting benefits for the average Chilean and
Singaporean citizens as well.
Mr. Taylor. If I could just add briefly, I think the
Chilean economy is a real success story in Latin America. They
have withstood lots of crises. A lot of that is because of the
openness of the economy. In the financial services area, they
are relatively open already, so the examples of the increased
openness are smaller than in the case of Singapore. But the
economic stability is improved when banks run more efficiently,
when there is more prudential investments and better
regulations. What we have found in Mexico and other countries,
that the foreign investment, again whether it comes from the
U.S. or other countries, improves the efficiency and the
regulatory oversight in ways that are beneficial for economic
stability.
Mrs. Biggert. It has been about the last 10 years that
Chile has had much more stability, isn't it? It seems to me
that before that there was pretty wild fluctuation in their
currency and the financial markets. Why is that?
Mr. Taylor. The Chileans have chosen a number of good
policies--the openness which is now even better with the FTA
that is coming, but the also the policy with respect to keeping
inflation down. They basically, it used to be they had hyper-
inflation for many, many years, big ups and downs, triple-digit
inflation numbers. In the early 1990s, they went to a policy
that focused on getting inflation down. It has been very
successful, but it is just one example of the improvement in
policies that they have had.
Chairman King. The gentlelady's time has expired. The
gentleman from Massachusetts, Mr. Frank.
Mr. Frank. Thank you, Mr. Chairman. I want to reemphasize
we are not talking here--no one is arguing, I believe, that
capital controls are always a good thing or they ought to be
mandatory. We are talking about a very extreme argument on the
other side that says they are never a good thing and they ought
to be prohibited, and that no government democratically elected
might be even allowed to experiment with them.
Mr. Taylor, you keep talking about the cooling off period,
but I am afraid the ice is in the eyes of the beholder here. It
is not as cooling off as you say, because while you have to
wait six months in the case of foreign direct investment and 12
months in the case of foreign direct investment and 12 months
in the case of portfolio investment to bring a complaint if you
are an aggrieved private investor, in either case if you decide
to bring it, in the first place that is the decision of the
private investor--no government intervention can dissuade you;
and secondly, your damages go back from the day it happened. In
other words, the six and twelve month cooling off periods are
cooling off periods when you can file your claim, but you do
not delay the effective of this. So that a country that decides
to impose controls on short-term capital, yes, someone might
have to wait 12 months, has to wait 12 months before claiming
damages, but if that private individual decides to claim
damages, it is the absolute right of that private individual to
go to the arbitration panel--there is no government role in
this on either side--and the damages accrue from the first day.
Isn't that accurate?
Mr. Taylor. That is accurate if the controls on these
particular types of capital last for longer than year and if
they substantially impeded transfers, yes.
Mr. Frank. Right. And of course, the definition of
``substantially impede'' is nowhere in the agreement. We have
not been able to get anybody to tell us what that means, and it
will be left to them. We ought to be very clear about this,
because these are very important policy issues, as all the
questions are made clear. But the ultimate determination is
left to these private arbitration panels which can be triggered
by private aggrieved individuals. So what is a substantial
impediment would be left to that group.
Now, you make a distinction here, which I am struck by,
because I do not think you carried through, frankly, with it in
policy terms, between foreign direct investment and portfolio
investment. I think if we were talking about foreign direct
investment, there would be much less objection here. You talked
about providing funds for workers. Short-term capital flows--
does our government really think that there are never times
when a country, particularly one that might not have a well
developed banking system--the gentleman from Illinois said,
well, the problem was not liberalized capital flows; it was a
poor banking system. But our problem is enforcing these capital
flows when people have weak banking system, and it seems to me
that is what--I see no indication you do not plan to do that in
any case. But are there no cases where controls on the short-
term capital flow in countries that do not have fully developed
regulatory systems would be a good idea?
Mr. Taylor. I think the important thing is they get the
prudential regulations in place so that the chances of
financial----
Mr. Frank. Okay. Let me ask you this question. I accept
that answer, but then the question is, does that mean that you
will not be including these provisions in any free trade
agreement with a country that does not have a well developed
regulatory system financially?
Mr. Taylor. I was indicating to Ranking Member Maloney, as
we go through and consider future free trade agreements, we are
going to have to consider what the countries want. As you say,
these are democracies.
Mr. Frank. Oh, let us leave aside what they want, because
the question is whether you will be pressing, the United States
will be pressing--is it a prerequisite for your insisting on
these kind of provisions that the trading partner in this case
have a well developed regulatory system? That would be
particularly a problem, say, with the free trade area of the
Americas. Let me ask you this specifically, does every country
that would be encompassed in the FTAA have a well developed
financial regulatory system, in your judgment?
Mr. Taylor. I think, as you know, the FTA agreements that
we are considering are with countries that we want to be doing
all the things with respect to their policies.
Mr. Frank. So there is no country that would be included in
the FTAA that does not have a good financial----
Mr. Taylor. Well, I hope that they can all improve and get
better. But your question about whether we insist on this
imposition, it is really not the way to think about it. We
negotiate with a point of view which we think is a good point
of view, a good philosophy. We have listened. We negotiated.
Mr. Frank. Mr. Taylor, I am sorry to have to say this, but
that is not true, and I know that first-hand. I have been in
conversations with the Ambassador of Singapore. The United
States market is the eighth wonder of the world. We have
developed fortunately for us an economy that is extraordinary.
Access to the American market, access to American capital is
obviously enormously important, particularly when you were
talking about bilateral agreements. The ability of an
individual country to refuse to deal with America is quite
minimal. I know as a fact that the Singaporeans would have much
preferred not to have had this. They were for free trade. They
did not want to give in to this, and I know this from the
ambassador from Singapore, who sought me out when my colleagues
and I objected in a letter that we sent to the Treasury, saying
do not push for this.
So I have to say I am disappointed by what I think is an
inaccurate characterization you give of these negotiations. I
think it is clearly a case where the enormous economic power of
the United States was put in the service of an ideology and
some economic interests, but I believe it was primarily the
ideology, and that the Singaporeans assented. I will tell you
this, and my time is up, but I think that probably also
accounts for the fact that your testifying partner has been
significantly less enthusiastic in this testimony than you have
been. I think it is clear that in fact this is the Treasury
Department imposing not just on Singapore, but on the U.S.
Trade Representative.
Thank you, Mr. Chairman.
Mr. Taylor. If I could just answer briefly, these are
negotiations. They are give and take. Different parties have
different interests. That must be clear in every single
negotiation that takes place, whether it is on a reduction for
trade in a particular good or a particular commodity or whether
it is trade in financial services or whether it is these
issues. We had a lot of discussion in our government on these,
and this agreement represents a compromise which was
negotiated.
Mr. Frank. I agree, but you have just acknowledged, I
think, the United States and Singapore saw themselves as having
different interests. I understand why the Singapore government
felt they had to give in to you on this important point,
although very reluctantly.
Chairman King. Mr. Mendenhall, do you want to comment on
the gentleman's observation on your level of enthusiasm?
Mr. Frank. I would note, Mr. Chairman, that was not a
volunteered intervention. I appreciate that.
[Laughter.]
Mr. Mendenhall. I generally have a penchant for
understatement. I am quite enthusiastic about these particular
agreements.
Mr. Frank. I would hate to see you when you were bored, Mr.
Mendenhall.
[Laughter.]
Mr. Mendenhall. Part of my silence on this issue is because
I was not at the table for most of this. I am newly appointed
to this position, and I observed much of it from afar. But I
think the points that Under Secretary Taylor has made are
correct. In fact, I know we fully endorse them. In our view,
the particular provisions that we negotiated on, or that my
colleagues have negotiated on capital controls strike an
appropriate balance between the regulatory interests and the
commercial interests. I think the points that Under Secretary
Taylor has made on those points are quite powerful. Again, just
a general comment on whether or not the United States was
unilaterally dictating the terms of these agreements, I think
that is--in fact, I know that is not the case. This was the
result of a compromise, as were many other provisions in the
FTAs. There were many things that we wanted to get at the end
of the day.
Mr. Frank. A compromise between our wanting it and their
not wanting it on this one issue. That is all I would agree.
Mr. Mendenhall. Again, to the extent that we wanted it and
they did not want it, I defer to Under Secretary Taylor. But
again, there are points of convergence and that is what the
compromise is about. That is what the negotiation was about and
that is where we ended up at the end of the day. Did both sides
get everything they wanted in every aspect of these FTAs? No,
probably not. This was a negotiated compromise. That is the
nature of what a negotiation is for a free trade agreement and
any other area.
Chairman King. I would advise the gentleman from
Massachusetts that is really an unfair standard to apply to
witnesses to expect them to match your level of exuberance.
[Laughter.]
That is a very unique level, and witnesses can have other
talents besides being as exuberant at the gentleman from
Massachusetts.
Mr. Frank. Well, if the majority would let me pick more of
the witnesses, we might have a little more energy here.
[Laughter.]
Chairman King. The gentleman from Florida, Mr. Feeney.
Mr. Feeney. Thank you, Mr. Chairman, and thank you,
gentlemen.
Earlier, one of my colleagues suggested that the
restriction on capital controls might tend to favor U.S. banks
and that investors would seek the protection provided by these
agreements. Granted that that is certainly a possibility, isn't
there also a corollary benefit that it will discourage
countries that otherwise might be in a haste to exercise those
capital controls on their own banks? And isn't there also the
possibility that those countries will focus increasingly on
sound monetary policy, good regulatory practices with respect
to their own financial institutions? And isn't there a
potential net positive effect on their internal mechanisms
coming from doing the right thing with respect to U.S.
investors and banks?
Mr. Taylor. Yes, I agree with that very much. The controls
and restrictions have benefits that sometimes go to particular
individuals, but they have harms that are broad. You are
pointing out some of the harms that can actually occur in the
country themselves. We are focusing on rights for foreign
investors, but the harms actually I think are more pervasive in
the country itself. Just for example, short-term capital flows
sometimes are bank loans, short-term bank loans. A lot of
businesses need bank loans for various purposes. So if there
are restrictions on those of any kind, it is harmful to the
businesses that are trying to get the loans. That is just an
example. So every time one of these restrictions is put in
place, it has harmful effects. In fact, I think people would
prefer not to use the restrictions and that is what we have
found in the case of Singapore and Chile. They would prefer not
to use them, and we gave them in this agreement an opportunity
for flexibility in case they really had to in the future, but
they were very reluctant to do it.
Mr. Feeney. Mr. Mendenhall, I do not know how enthusiastic
you can get about helping countries reform their banking
regulation and fiscal policy and monetary policy, but maybe you
can add to that.
Mr. Mendenhall. I think in large part, it would be our
policy that the countries should reform independently, even if
what we do in the free trade agreements. The free trade
agreements are a useful tool to prod them along, to lock in the
commitments that they have already made.
Mr. Feeney. And just so competition helps improve goods and
services in countries, so it may improve regulatory practices
with respect to financial institutions.
Mr. Mendenhall. I think that is correct, and I think that
has been our approach on our whole trade agenda. That is one of
the reasons we are being so aggressive on our free trade
agreements is we expect this competition for liberalization,
which is why we are pursuing liberalization of financial
services, both in the WTO and on the free trade agreement side.
We might be able to get more or less in some areas, and make up
for it or complement it in other areas. So I think that is
right.
Mr. Feeney. If I can, several of my colleagues here, and I
think at least one of the professors is going to address this,
has suggested that there is some huge difference between free
trade practices and free capital flow regulatory issues. They
have actually suggested that some of us free traders are not so
free when it comes to letting countries regulate their own
capital flow. But indeed, isn't there another way to look
through the prism at this, and that is that to protect a
country's ability to essentially confiscate or freeze the flow
of capital actually encourages protectionism in those
countries. What you are protecting is faulty monetary policy
and bank regulations. Can't you look at it through the free
trade prism?
And finally, because I see my time is almost up, you will
not get to respond if we wait to the suggestion that bilateral
agreements somehow will ultimately interfere with the ability
to deal with multinational approaches to free trade, so if I
could have the gentleman weigh in on the first question with
respect to aren't we really suggesting, some of my colleagues,
that what we want to do is to protect bad regulatory behavior,
(A); and (B) is it true that promoting bilateral agreements
with friends is somehow going to undermine the ability to deal
with multinational free trade throughout the globe?
Mr. Mendenhall. Sure, I will address those comments in
turn. I think the dichotomy between free trade and free
movement of capital is a bit false. What we are really talking
about is free markets, opening free markets. So that principle
I think would apply equally to both free movement of trade and
free movement of capital. The nature of those problems may
differ. The free movement of capital and the regulatory issues
related to financial services are complicated, in many cases
more complicated that dealing with reductions of tariff
barriers and that type of thing. But I do not think that
changes the underlying fact that the free market principles is
what we are trying to enshrine and promote in these trade
agreements.
On the point about whether, if I understood the question,
is whether bilateral agreements, the pursuing of a bilateral
trade agreement agenda undermines or undercuts the multilateral
initiative--did I understand that question correctly? Okay. We
do not believe that. In fact, we believe that they complement
each other. One of the points I wanted to raise in my testimony
was that this is certainly Ambassador Zoellick's philosophy and
it is the philosophy that we are pursuing, that we are pursuing
bilateral, regional and multilateral initiatives at the same
time, precisely to encourage competition and liberalization. In
fact, we are even doing it within the same region. We are
pursuing free trade agreements with Central American countries.
We just concluded the trade agreement with Chile. At the same
time, we are pursuing the FTAA. We are engaging in these
bilateral discussions because you can frequently make much more
progress in a bilateral context than when you are negotiating
in a multilateral context. But they all have value and they all
complement each other in many ways. The advantage of the
bilateral context is, one, you can make progress; two, you can
tailor the specific provisions if you need to to specific
problems that are in a country. You do not always get reduced
to the lowest common denominator.
Chairman King. The gentleman's time has expired. The
gentleman from Vermont.
Mr. Sanders. Thank you very much, Mr. Chairman.
What I would like our guests to do, and thank you very much
for being with us today, is, I am going to make some what I
believe to be statements of fact. When you disagree with me
with exuberance or not, just tell me where I am wrong.
The United States believes, this administration, previous
administrations believe very strongly in pushing free trade and
globalized liberalization. This country today has a $400
billion trade deficit, the largest in our history. We have $100
billion trade deficit with China. In the last two years, we
have lost 1.7 million manufacturing jobs, and at 16.5 million
jobs, we now have the lowest number of manufacturing jobs in
the United States in the last 40 years. Anything I have said
that you disagree with? I do not see any disagreement, Mr.
Chairman.
Mr. Taylor. Just on the facts, of course.
Mr. Sanders. Yes.
Mr. Taylor. There is a causality that is implicit, but we
can come back.
Mr. Sanders. If you disagree with the facts, please, but
you are not disagreeing with what I have said.
You will not disagree with the fact that over the last
number of years there has been a transition in our economy from
manufacturing to service industry jobs, and that most service
industry jobs pay workers less than manufacturing jobs. That is
what is happening in the United States, which indicates to me a
failure of so-called free trade. Let me quote from the New York
Times of September 4, 2002. I think we can all agree that the
flagship of free trade, the model that we looked at, is NAFTA.
The New York Times, by the way, strongly supported NAFTA when
it was passed; article, September 4, 2002--you will forgive me.
I am, needless to say, excerpting. ``It has been two decades
since Mexico committed itself to free trade reforms aimed at
propelling this country into the developed world. But
government statistics show that economic liberalization has
done little to close the huge divide between the privileged few
and the poor and left the middle class worse off than before.
According to a recent government report, in the year 2000 half
the Mexican population lived on about $4 a day, with scarcity
shifting along with the population from rural regions to
cities. Some 10 percent of Mexicans at the top of the economic
period controlled close to 40 percent of the nation's wealth.
Meanwhile, the 35 percent of Mexico's population that lives in
the middle, with average earnings of about $1,000 a month,
spirals slowly downward. The economist Rogelio Ramirez de la
Oze, said that in the 1970s, when Mexico's population was 50
million and the country had begun to enjoy the benefits of an
oil boom, some 60 percent of Mexicans were middle and working
class. Their numbers and buying power have declined
dramatically since then,'' Mr. Ramirez said.
In other words, free trade and NAFTA has failed for Mexico.
It has failed for the United States' workers in the United
States. I believe that if you look at what is going on in
Argentina, what is going on in Venezuela, what is going on in
Brazil and other countries throughout Latin America, you will
find the same story.
So my first question, starting off, and there are two
questions I would like to ask, Mr. Mendenhall, is why are you
here telling us that we should defend a policy which has failed
American workers and failed the poor people and the middle
class of developing countries? My second questions--of course,
we are here dealing with financial services--let me quote from
Business Week, February 3, 2003, quote, ``In the past year,
Bank of America has slashed 3,700 of its 25,000 tech and back-
office jobs, an additional 1,000 will go by March. Ex-Bank of
America managers and contractors say one-third of those jobs
are headed to India, where work that cost $100 an hour in the
U.S. gets done for $20. Bank of America acknowledges it will
outsource up to 1,100 jobs to Indian companies this year. My
second question is, in terms of free trade in financial
services, how many decent-paying, middle class jobs do you
expect will be lost?
Two questions, why are you telling us to expand free trade
when it has been by and large a disaster for working people in
this country and for poor people abroad? Number two, in terms
of financial services, how many jobs will American workers
lose? Mr. Mendenhall, could you start it please?
Mr. Mendenhall. Sure. I do not know all the numbers that
you cited in the beginning. I cannot take issue as to whether
they are right or wrong. I will assume they are. I do not know
the sources. I think there is, as Under Secretary Taylor
started to explain earlier, there is a tendency, I think, to
load too much onto trade, perhaps for the bad and for the good.
Trade is often blamed for the world's evils and on the other
hand, trade is often viewed by some as the panacea for all the
world's ills. The true answer is probably somewhere in the
middle. So when you talk about loss of manufacturing jobs or
the other factors that you cited, Under Secretary Taylor is
entirely correct that we have to look at the cause of those
particular losses. So I do not know for sure what the causative
factors are for those losses.
Mr. Sanders. If I may, sir, thank you--but when the
evidence is overwhelming that companies are laying off American
workers and going to China and to Mexico, can you doubt that
trade and this policy plays a significant role in limiting
manufacturing jobs, cutting back on manufacturing jobs in
America?
Mr. Mendenhall. I can tell you that the United States----
Mr. Feeney. [Presiding.] The gentleman's time has expired.
Without objection, he is yielded another 30 seconds.
Mr. Sanders. I thank the gentleman, but I would ask for
roughly the same amount of time as some of my colleagues had. I
am not going to go on indefinitely. Do we have a vote, by the
way? Did I hear bells go off? Did anyone hear that? No.
Mr. Feeney. We will try to let you know, but if we can, to
answer that question, we will try to go on and stick to the
five-minute rule. We do have another panel of witnesses.
Mr. Sanders. Okay. Yes, I understand.
I understand your point that trade is not the end all.
There are other factors, but I find it very difficult to hear
people keep coming forward when the evidence is overwhelming
that for the middle class, working class in this country, and
for poor people abroad, this policy has largely failed. Mr.
Taylor, did you want to comment on that?
Mr. Taylor. I do not think it has failed at all. I think
you are pointing to some trends about manufacturing and
services that have been going on for many, many years. Our
productivity in manufacturing is increasing at leaps and
bounds, so to provide the same number of products, workers are
going into services, which the United States has a great
comparative advantage; and some very sophisticated services,
some very high-paying services. So I think that is something
that is going on, and as long as it is being done in a way that
is beneficial to workers and firms, it is fine.
Mr. Sanders. It does not concern you that millions of
American jobs are now in China, where people do jobs at 30
cents an hour.
Mr. Taylor. I do not think millions of American jobs are in
China.
Mr. Sanders. You do not believe that?
Mr. Feeney. The gentleman's time has expired. The gentleman
from Texas is recognized for five minutes.
Mr. Hensarling. Thank you, Mr. Chairman.
Mr. Secretary, when the Administration sits down to
negotiate a trade agreement with Singapore, is the
Administration there to advocate, negotiate on behalf of
Singapore's interests or the U.S.'s interests?
Mr. Taylor. No, it is on behalf of the U.S. interest.
Mr. Hensarling. For those who wish to invest in Singapore,
for those who wish to trade in Singapore, have you heard, have
you seen any evidence, have you heard any evidence, or
testimony that they prefer capital controls, or that they want
to increase the risk of the loss of their capital?
Mr. Feeney. Mr. Taylor and Mr. Mendenhall, if you would
pull those mikes a little closer to you we could hear better
and the recording secretary could hear you better.
Mr. Taylor. No, I have not heard requests for capital
controls from U.S. financial representatives.
Mr. Hensarling. Mr. Mendenhall, in your testimony, you
indicate that the U.S. provides a substantial portion of the
world's financial services, which I think many members of this
panel are aware of. You point to several statistics that show
we run a trade surplus in certain aspects of financial
services. I must admit I am not one who is concerned about
trade deficits. For example, I run a trade deficit with my
barber every month. I run a trade deficit with my grocer every
month. I am more concerned about whether or not my income is
increasing and whether I have enough income to pay my bills.
For those who are concerned about the trade deficit figure, if
we are running a surplus in many aspects of financial services,
a trade surplus, can you speak to the impact of capital
controls on the further export of U.S. financial services?
Mr. Mendenhall. I can speak to it briefly. On the surplus
issue, I think on the services side, not just financial
services, but services as a whole, the United States is
essentially running a trade surplus overall, as opposed to the
trading goods sector. On the impact of capital controls, I can
speculate what that would be. I would imagine the riskier that
the investment would be in foreign markets, whether they be
Singapore, Chile or elsewhere, if there is a high risk of
capital controls being imposed that it would lessen the degree
of investment and lessen the degree of cross-border
transactions, and therefore reduce the surplus, would be my
speculation.
Mr. Hensarling. Mr. Secretary, can you speak, give us a
little bit more detail about the regulatory transparency that
has been negotiated in these two trade agreements?
Mr. Taylor. The regulatory transparency in the case of
Chile is one in which they have agreed to, for example, make
formal notification if there is a change in regulation, so that
becomes very clear and is not a surprise. In the case of
Singapore, there is just more information put out about the
regulations, more transparent in the sense of more public
notice in general.
Mr. Hensarling. Thank you.
Mr. Mendenhall. If I could just say a word about that as
well, the transparency provisions I think are fairly central to
the financial services chapter. I know it is of critical
importance to our own financial services industries. In many
ways, it parrots what we do in the United States. We have a
publication and comment period. We have time frames for issuing
or responding to applications for permits for financial
services and so on. The reason I wanted to come back to the
point is because I got an earlier question dealing with how
these agreements might promote stability in some of these
countries. I think the transparency provisions by making the
markets more open, promoting information sharing, promoting the
formulation of good regulations--all of that I think
contributes to the rule of law and the stability of these
financial regimes. Thank you.
Mr. Hensarling. Thank you, Mr. Mendenhall. In the few
seconds I have left, Mr. Chairman, if I could simply state for
the record, coming from Texas, which is a lot closer to the
nation of Mexico than the state of Vermont, I can tell you that
NAFTA has been an incredible success on both sides of the
border. Approximately one out of six jobs in Texas results from
export and trade, principally with Mexico. If you have traveled
south of the border, you see how many people have been
liberated from poverty because of the American investment along
the border, particularly in the maquiladors.
Thank you, and I yield the balance of my time.
Mr. Frank. Would the gentleman yield for one second?
Mr. Feeney. This is not the geography committee.
The gentleman from New York, you are recognized for five
minutes.
Mr. Manzullo. Illinois is a long way from New York.
Mr. Feeney. I am sorry. Mr. Manzullo, you are recognized.
Mr. Manzullo. I appreciate it. Thank you very much.
What was that, Barney?
[Laughter.]
It is good to see you here. I would like to see everybody
here on one panel, because I would--it would be delicious if
Professor Bhagwati were there and able to point for point meet
with Ambassador Zoellick on the efficacy of these regional free
trade agreements, as opposed to world free trade agreements as
a whole. I do not know if I agree with his calling it a
Leninist approach, but that certainly would make things pretty
interesting.
I have this question. I am the Chairman of the U.S.-China
Interparliamentary Exchange. We have met with the members of
the National People's Congress on five different exchanges now.
We just came back from China in January. Mrs. Biggert and Mr.
Saunders were with us. One of the problems in the U.S.-China
WTO accords is the fact that even with the liberalization or
the ability of the United States' financial institutions to
establish a presence in China, there has been this incredible
standard that the Chinese have been setting. I do not want to
call it deposit reserves, but in terms of almost a separate
licensing requirement. It is obviously a non-tariff barrier,
but it is just not working to get our people in there.
I know it is not related to the issue of capital flight or
anything like that, but what have we learned from the fact that
there perhaps is a lack of specific language in the U.S.-China
WTO accord, and to take that lesson and put it in future
agreements so that we do not have the continuous problem of
fighting with the foreign government as to exactly what the
reserve requirement is.
Mr. Mendenhall. I think I am going to have to defer on that
question myself. I would be happy to meet with you afterwards
to talk about the specifics. I do not know the specifics of
that.
Mr. Taylor. Just briefly, the WTO agreements are of course
much different than these FTAs we are talking about, which are
regional.
Mr. Manzullo. Regional.
Mr. Taylor. Yes, but not only that, they get better
agreements in some sense; more substantial tariff reductions.
Perhaps that is the issue that Professor Bhagwati is concerned
about. But the nature of the FTAs is they do get more specific
about these kinds of things. In fact, these capital control
issues we were talking about are just exactly the kind of
deposit regulations you are referring to. In this free trade
agreement with Chile, we have endeavored to reduce the
likelihood that those would take place. It was very specific.
That is one of the advantages of free trade agreements, or more
general trade agreements. The WTO is not as substantial as
these free trade agreements.
Mr. Manzullo. But it could have been. I know, Mr.
Mendenhall, you are the new guy on the block. I would love you
to stop by the office and discuss this in depth, obviously at a
later time. But there is considerable frustration going on.
Why, when we entered into the China-WTO accession accord, and I
know that is before you came on board, why can't you have just
in the matter of--Mr. Taylor, if you want to answer this--why
can't you have strict provisions with regard to that problem in
banking reserves, as you would in a regional agreement?
Mr. Mendenhall. I can answer the question at a certain
level of generality.
Mr. Manzullo. That is Okay. Could you pull the mike closer,
Mr. Mendenhall?
Mr. Mendenhall. Sure.
Mr. Manzullo. Thank you.
Mr. Mendenhall. I can answer the question at a certain
level of generality because I do not know the specifics of the
issue you are referring to. But I think the tendency in a
multilateral setting is that everything tends to get sort of
reduced, if you will, to the least common denominator. In a
bilateral or regional setting, the trade-offs are a lot
clearer. The wants on both sides are a lot clearer, and it is
easier to just trade one for the other as a single undertaking,
if you will. The WTO has a great advantage, of course, that the
global trading community is there, but it has the disadvantage
of making the trade-offs and the gamin of the system, if you
will, must be more complicated, and it is just easier to get
higher standards agreements, if you will, in a bilateral or
regional setting.
Mr. Manzullo. Okay. I appreciate that. That really goes to
the guts of Professor Bhagwati's statement in there. Thank you
very much. I look forward to meeting with you sometime later.
Mr. Feeney. And thank you, Mr. Taylor and Mr. Mendenhall. I
assume that if members of the committee have additional
questions and would submit them in writing, that you will do
your best to reply.
Mr. Mendenhall. Thank you. I appreciate the opportunity of
testifying today.
Mr. Feeney. Thank you very much.
We have another distinguished panel. While you are on your
way up, I will try to introduce you briefly so we can get
straight into your testimony and introductions: Dr. Bhagwati,
Andre Meyer Senior Fellow in International Economics, Council
on Foreign Relations; Dr. DeRosa, President of DeRosa Research
and Trading, Incorporated; Dr. Henry, Associate Professor of
Economics at Stanford University Graduate School of Business;
Dr. Lackritz, President, Securities Industry Association; Mr.
Tarullo, Professor of Law at Georgetown University Law School;
and Mr. Vastine, President of the Coalition of Services
Industries.
Welcome. I think we have got your name tags set up in
order. As soon as you get seated, we will invite Dr. Bhagwati
to start his testimony.
STATEMENT OF JAGDISH BHAGWATI, ANDRE MEYER SENIOR FELLOW IN
INTERNATIONAL ECONOMICS, COUNCIL ON FOREIGN RELATIONS
Mr. Bhagwati. Thank you, Mr. Chairman.
I think a lot of what I am going to say has been partly
covered by the morning's discussion, but I will still indicate
some principal points to recap and bring my own emphasis to
bear. I think there are three questions before this committee.
One is should we seek to impose serious restraints on the
developing countries' ability to use capital controls, just a
general question. Two, should we do this as part of our trade
agreements. And three, what can we even say about the wisdom of
the specific provisions which we have in the two agreements
before us? I will take up these issues in that order.
First, on the general wisdom of putting restraints on the
use of capital controls, I am not encouraging people----
Mr. Frank. Professor Bhagwati, could you pull the mike a
little closer to you please? Thank you.
Mr. Bhagwati. On whether we should impose constraints, as
against encouraging people to use these, we have to be very
clear whether we want to restrain countries from using these
kinds of capital controls. I think after the Asian financial
crisis of 1997 and 1998, nearly all economists in my judgment
and information, and the International Monetary Fund, publicly
now, have become much more cautious about the freedom of
capital flows unregulated, you know, total freedom like total
free trade. I would distinguish between three different
contexts to understand this. First, should we pressure
countries that are not on capital convertibility at all, to
hasten their progress to doing so? IMF and U.S. Treasury were
in fact doing this prior to the Asian crisis.
But both the crisis and the fact that India and China
escaped it, I think as Under Secretary Taylor was somehow
forgetful when one of you asked as to whether there were
examples of people who did well by not going in for capital
convertibility, and these are two gigantic countries, which
have been outward-oriented on trade, on foreign investment
coming into them--China more so than India, but India has
caught up. They escaped the crisis, the contagion altogether
and they survived. So we do have examples where countries were
prudent, maybe excessively prudent, probably too closed--one
can discuss that--but they really escaped it. So I think IMF
certainly, and economists have become much more cautious and
prudential compared to the pre-Asian crisis situation. Second,
when you are more or less open--this is a different problem--
when you are more or less open financially anyway, should you
also not be prudent at the same time? The Chilean example with
the Chilean tax, which might be looked upon as a token tax at a
country level, was designed to moderate in-flows. So flows
coming in, when they seemed too large relative to the reserves
and to the fundamentals at hand--your export capabilities and
so on--and there I would say, again, people concede everywhere
that such a tax, as against a permanent capital control, is
actually a good weapon to have. Not that you want to rush and
in use it all the time, but it is something you want to be able
to have as a weapon under your command.
The third is a more difficult one, namely that when you
actually have panicky out-flows happening, as part of crisis
management, do you then resort to capital controls? That is a
different problem, again. Now, the Malaysians, of course, used
them during the Asian crisis, and there was more controversy on
this one. Again, my own judgment from whatever I have studied
on this problem, is I am inclined to agree with those who have
actually argued that Malaysians did rather well out of it,
compared to the countries which took the then-prescription of
the IMF.
In conclusion, I would say on the first question, we are
far more conscious today about the wisdom of not taking an
ideological or a financial lobby-driven position against the
use of capital controls. I think today we certainly would be
emphasizing in the classroom and in every course we will teach
that, look, this is not on a par with free trade. I think one
of the Congressman asked me, you know, why is this different?
The reason it is different is that with trade, which I am a
great proponent of, as the Congressman from Illinois pointed
out, that is a very different kind of proposition. I say that
if I exchange my surplus toothbrush with some of your surplus
tooth paste, and we remember to brush our teeth before we go to
bed, we are both going to get white teeth. And the possibility
of our teeth being knocked out in the process is very
negligible. But when it comes to the analogy on capital flows,
it is obvious that really the analogy is like fire. You can
use, as I have pointed out in my written testimony, Tarzan can
roast his kill, but if he goes back as the Earl of Greystoke
and he plays around with fire, he can bring his ancestral home
down. So you have to be prudent. It is a very elementary point,
and only ideologically one could be against it today. So I
think that is number one.
Now, two, putting any such restrictions----
Mr. Feeney. Doctor, if I can, we have your written
testimony, and unfortunately as have a number of distinguished
witnesses.
Mr. Bhagwati. Okay. Let me just make one point quickly.
Mr. Feeney. Yes, sir. Wrap up.
Mr. Bhagwati. On putting any such restrictions down in a
trade agreement, I think the Under Secretary was right, that
trade liberalization should include services. We have a general
agreement on trade in services. But that is not the issue we
are discussing. We are discussing whether we should have
capital controls ruled out, and there it seems to me that there
is a real problem about bringing this into trade agreements. It
is not just Congressman Frank or me and others who are worried
about this. Today, we have had problems, as you know, with
Chapter 11 and NAFTA, if this is where overly liberal
ideological views seem to have been taken on takings. And that
got us into a lot of trouble.
Today, all the NGOs are anti-globalizers. They are very
concerned about post-financial crisis about what we are doing
on the financial issue. If we put something like this into a
trade agreement, no matter which trade agreement, that is
immediately going to attract flack. So I think it is
politically imprudent to mix up trade treaties with capital
account controls. If you want to shove it into an investment
agreement, fine, then more of the objections will go there, but
trade is bad enough--Congressman Sanders was exaggeratedly
pointing to its perils, in fact erroneously so in my view--but
you have positions like that. You do not want to mix it up and
make and over-burden your case.
[The prepared statement of Jagdish Bhagwati can be found on
page 51 in the appendix.]
Mr. Feeney. Thank you, Dr. Bhagwati.
Mr. DeRosa?
STATEMENT OF DAVID F. DEROSA, PRESIDENT OF DEROSA RESEARCH AND
TRADING, FREDERICK FRANK ADJUNCT PROFESSOR OF FINANCE, YALE
SCHOOL OF MANAGEMENT
Mr. DeRosa. Good afternoon, Mr. Chairman and members of the
subcommittee. I am David DeRosa. I am president of DeRosa
Research and Trading, and I am an Adjunct Professor of Finance
at the Yale School of Management, where I have taught
international finance for the last six years.
My testimony is going to be on my position on capital
controls. In the middle 1990s and continuing up to the present
time, a great many emerging market nations experienced
cataclysmic financial crises. Many of these same nations had
previously been identified as growth miracle economies.
Examples are Mexico in 1994; Thailand, Indonesia, Malaysia in
1997; South Korea, 1997, 1998; Russia, 1998; Brazil, 1998;
Turkey, 2001; Argentina, 2002. These were devastating crises,
much economic suffering ensued; inflation, unemployment,
bankruptcies were widespread.
Now, stock and bond markets plunged and in all of these
cases, the national currencies depreciated greatly and the
foreign exchange regime that governed those currencies were
abandoned. The reaction to the crisis has been largely to
blame--the international capital markets and in particular the
foreign exchange market. Some say the afflicted countries were
victims of capricious international capital flows. Hence, we
are here today to discuss capital controls in the context of
some trade legislation.
I studied economics at the University of Chicago for 10
years. I have a bachelor's and a Ph.D from the school in
economics and finance. I have been a currency trader at a major
bank. I have been an investment manager and I have been a hedge
fund manager. At present, I am a member of the board of
directors of two of the most successful hedge funds. That does
not affect my opinion on capital controls. It just explains my
experience.
Now, I want to call your attention to this, because it is
my sincere belief that much of what happened in the 1990s and
the last three years has been totally misunderstood. Take this,
for example: All of the above-mentioned crises that seems to
have shaped our thinking, all except one, Malaysia, which I
will come to, took place in economies that had some form of
fixed exchange rate regimes. In fact, the climax of all of
these crises were when the fixed exchange rate regime exploded
or was terminated. Each crisis was marked by a sharp out-flow
of capital prior to the moment when the fixed exchange rate
regime was scrapped. Once it was scrapped, there was sharp
depreciation in the currencies, sometimes as much as 70
percent.
In each case, the government replaced the fixed exchange
rate regime with a floating exchange rate regime. And you know
what? No more crises. No more crises. Once a floating exchange
rate, no more currency crises. All of these countries had
accumulated massive amounts of private and public debt
denominated in U.S. dollars. So when the exchange rate
depreciated, the local value of those debts magnified up,
sometimes two or three times. Preceding the crises, an enormous
amount of foreign capital flooded into these countries,
sometimes buying local securities, sometimes as direct
investment, sometimes as leveraged transactions. But most
important, all of these trades, which are called carry trades,
were really not investments per se in the country, they were
investments in the fixed exchange rate regime. Under the
umbrella of safety that they thought they had, people invested
in these countries to get superior interest rates, hoping that
the fixed exchange rates would preserve the value of their
capital.
History has shown that fixed exchange rate regimes are
crisis-prone. Almost all of them have blown up. It is an
endemic problem, and it is not just emerging markets, it is
major countries as well--witness Bretton Woods and the exchange
rate mechanism. The reason why currencies depreciate so
violently when fixed exchange rate regimes are abandoned is
that domestic dollar borrowers and foreign investors all rush
to hedge their positions. So it is the case of a crowded
theater, 200 fat men, somebody yelled ``fire,'' and it is a
narrow doorway. Governments in crises almost always make these
crises worse, if not considerably worse, by enacting bad
responses that exacerbate the situation. Thailand, Indonesia,
Russia, Brazil and Argentina stand out as especially poor
examples of how to respond to financial crises.
Now, we have this myth that Malaysia found a kinder and
gentler way by imposing capital controls. The fact is, Malaysia
imposed them 14 months after the crisis started. This was a
spectacular case of locking the barn door after the horse was
out. In fact, Malaysia also simultaneously pegged the ringgit
at 3.8 to the dollar and that is where it is today. And
subsequently, all of the other Asian currencies have rebounded
substantially. What relief Malaysia got was----
Mr. Feeney. Dr. DeRosa, if you can wrap up. Thank you.
Mr. DeRosa. Right. It was simply because it pulled a fast
one. It devalued the ringgit relative to its neighbors.
So the point is that you do not really have to worry about
these crises or capital flows. They are a function of fixed
exchange rate regimes. You do not need the capital controls.
They are a bad idea.
Thank you very much.
[The prepared statement of David F. DeRosa can be found on
page 64 in the appendix.]
Mr. Feeney. Thank you.
Mr. Lackritz? I am sorry. Dr. Henry?
STATEMENT OF PETER BLAIR HENRY, ASSOCIATE PROFESSOR OF
ECONOMICS, STANFORD UNIVERSITY GRADUATE SCHOOL OF BUSINESS
Mr. Henry. Mr. Chairman, members of the committee, my name
is Peter Henry. I am Associate Professor of Economics at the
Stanford University Graduate School of Business. I am also
Faculty Research Fellow at the National Bureau of Economic
Research. My research is funded by the National Science
Foundation's Early Career Development Program. I have written
extensively on the economic effects of capital account
liberalization.
Thank you for the opportunity to discuss the implications
of my research for the financial services component of the
recent U.S. trade agreements with Chile and Singapore. My
testimony consists of three brief general points. Point number
one, what is my position on the importance of free trade? Free
trade in goods, also known as trade liberalization, is the
linchpin of globalization. All countries can benefit from free
trade because free trade allows countries to export those goods
for which they are low-cost producers, and import those goods
for which they are high-cost producers. This kind of
specialization brings two specific benefits. First, countries
get to consume goods at a lower price than would be possible if
instead of importing the goods, the countries produced them at
home. Second, specializing in the production of goods at which
they are more efficient raises countries' gross domestic
product.
Trade liberalization is not costless, however. Liberalizing
trade may cause unemployment by driving inefficient producers
out of business. In principle, however, the overall gain in
gross domestic product that result from free trade are
sufficiently large to pay for the cost of retraining workers in
redundant industries. In other words, all members of society
can be made better off from trade liberalization when it is
judiciously applied. Therefore, we should take the lead in
promoting worldwide free trade by continuing to open our
borders to foreign goods and encouraging other countries to
follow suit. The recent trade agreements with Chile and
Singapore provide a small step in the right direction.
Point number two, what is my position on the importance of
capital controls? A heated debate over capital account
liberalization has followed in the wake of financial crises in
Asia, Russia and Latin America. Opponents of the process argue
that capital account liberalization invites speculative hot
money flows, increases the likelihood of financial crises, and
brings no discernible economic benefits. Some economists have
gone so far as to assert that open capital markets may actually
be detrimental to economic development. I believe that there is
a serious flaw with such reasoning. This flaw stems from the
fact that those who oppose capital account liberalization have
failed to define exactly what they mean. Why is it important to
define precisely what one means by the term capital account
liberalization? The reason is that there are many different
types of capital account liberalization. At a minimum, we need
to distinguish between two categories: those that involve
equity and those that involve debt.
Consider first equity market liberalization--opening the
stock market to foreign investors. My research demonstrates
that three things happen when economies open their stock
markets to foreign investors. First, the cost of capital falls
for companies that are listed on the stock market. Second, in
response to the reduction in their cost of capital, the
companies that are listed on the stock market increase their
investment in physical assets. And third, as a result of the
increase in investment, productivity rises and the country's
growth rate increases by more than 1 percentage point per
annum. Since the cost of capital falls, investment booms and
economic growth increases when countries liberalize the stock
market. The view that capital account liberalization brings no
real benefits seems untenable.
Liberalization of debt markets, on the other hand, has
often led to great difficulty. For example, excessive short-
term borrowing in dollars by banks, companies and governments
have played a central role in the onset of almost every
emerging market financial crisis during the 1990s. In essence,
the mismatch between the term structure of borrowers' assets,
which were typically long-term and denominated in local
currency, and their liabilities, which were short-term and
denominated in dollars, placed these countries in an extremely
vulnerable position. Any bad news that made the lenders
reluctant to extend new loans was bound to create an immediate
liquidity problem. So we have to distinguish between debt and
equity. Equity market liberalizations bring about good results;
debt market liberalizations are much more problematic.
Point number three, and last point--the lessons for this
and future agreements on capital controls. The evidence I have
outlined in this report can be distilled in a few key lessons
for the capital controls portion of the Chile and Singapore
free trade agreements. First, the liberalization of dollar-
denominated debt flows should proceed slowly and cautiously.
This agreement, as well as all future agreements, should
refrain from any language that inadvertently pushes countries
into prematurely liberalizing dollar-denominated foreign
borrowing. The second lesson is that all the evidence we have
indicates that countries derive substantial economic benefits
from opening their stock markets to foreign investors. There is
no reason to think that Chile and Singapore will be any
different in this regard.
Thank you.
[The prepared statement of Peter Blair Henry can be found
on page 151 in the appendix.]
Mr. Feeney. Thank you, Dr. Henry.
Mr. Lackritz, welcome and thanks for being here.
STATEMENT OF MARC E. LACKRITZ, PRESIDENT, SECURITIES INDUSTRY
ASSOCIATION
Mr. Lackritz. Thank you, Mr. Chairman. It is a pleasure to
be here. Thank you for the opportunity to testify. I am Mark
Lackritz, president of the Securities Industry Association. I
want to testify in very strong support of these bilateral free
trade agreements with both Chile and Singapore.
These agreements will result in increased commerce between
our respective countries, and in both cases the already close
economic relationships will be further strengthened, providing
new opportunities for U.S. securities firms and additional jobs
in the United States. Importantly, we believe these agreements
are excellent precedents upon which to build and negotiate
ongoing and future bilateral and regional trade discussions.
Both agreements successfully achieve many of the securities
industry's specific objectives, including, first, permitting
100 percent ownership and market access. Both of these
countries are open market and provide U.S. securities firms
with full market access by the establishment of a subsidiary or
the acquisition of a local firm. Since the conclusion of the
1997 WTO financial services agreement, both countries have
undertaken extensive liberalization of their financial services
markets. These agreements not only lock in current levels of
access, but also produce commitments by both countries to
eliminate and reduce some of the remaining establishment
barriers.
In terms of specific commitments, the FTA would for the
first time afford legal certainty to U.S. firms to establish a
wholly owned affiliate in Chile to provide asset management
services on a national treatment basis. Singapore also made
commitment guaranteeing U.S. membership on the Singapore stock
exchange, as well as for the acquisition of equity interests in
local securities firms.
Increasingly, services must be delivered through a business
presence in the host country. As a result, the ability to
operate competitively through a wholly owned commercial
presence or other form of business ownership must be a
fundamental element of any agreement. These agreements
guarantee the ability of U.S. securities firms to enter into
these markets through the establishment of a subsidiary or the
acquisition of a local firm. Once established, U.S. securities
firms will receive the same treatment as domestic companies.
For example, the free trade agreement with Chile provides
national treatment to U.S. asset management firms in managing
the voluntary portion of Chile's national pension system, and
the ability to manage the mandatory portion of the pension
system without arbitrary differences between the treatment of
providers. In Singapore, U.S. firms will now be able to compete
for asset management mandates from the government of Singapore
investment corporation.
In addition, obtaining commitments on regulatory
transparency was our industry's major goal in the agreements
with Chile and Singapore. We view the provisions contained in
these agreements as excellent, and view the FTAs as important
precedents for transparency of future efforts. The specific
financial service transparency commitments in the FTAs will
require that rules cannot be adopted without appropriate public
notice and opportunity to comment; that requirements and
documentation for applications be clear; and that decisions on
applications be made in a specified or reasonable time. The
ability to freely transfer and process information is essential
to the business of modern financial services firms. Indeed,
many products such as instruments built around market indices
that are vital to smoothing out risk, could not function
without timely data flows. Nevertheless, too few countries have
committed to this key link in the financial services
infrastructure. In this regard, commitments by both Chile and
Singapore mark a major step forward. Chile made no commitments
in financial information in the 1997 GATT agreement, while
Singapore made a limited commitment. The FTAs will now give
U.S. firms the legal certainty to process and disseminate
financial information both domestically and cross-border.
As a general matter with respect to capital transfers, our
members believe that restrictions on capital flows deprive both
parties of the benefit of cross-border investment. This is of
particular concern to financial services companies and others
engaged in portfolio investment. We welcome the general
commitment in both agreements to permit the free and immediate
transfer of capital related to an investment. However, we
regret that both agreements contain exceptions to this general
commitment. Our members fervently hope that these exceptions to
free capital movements will not form a template for future
agreements.
In conclusion, Mr. Chairman, we believe these agreements
offer Congress another opportunity to secure open and fair
access to foreign markets for U.S. firms and our clients. This
pact will result in benefits to consumers and businesses in
both countries, as well as globally. We look forward to
continue to work with both this committee and the
Administration in developing a fair, rules-based trading system
that enhances U.S. economic competitiveness.
Thank you very much.
[The prepared statement of Marc E. Lackritz can be found on
page 161 in the appendix.]
Mr. Feeney. Thank you.
Mr. Tarullo, please pull that mike close to you so we can
hear you.
STATEMENT OF DANIEL K. TARULLO, PROFESSOR, GEORGETOWN
UNIVERSITY LAW CENTER
Mr. Tarullo. Thank you, Mr. Chairman.
Mr. Chairman, I am struck by the fact that it is Chile and
Singapore we are talking about here. Chile and Singapore have
been among the most exemplary developing countries in terms of
their economic policies, their financial policies, and the
orthodoxy of those policies. The fact that both of those
countries, neither of which have imposed capital controls on
out-flows in recent decades, asked that they be allowed to
retain some capacity to impose capital controls in exigent
circumstances seems to me a reason why this committee and the
Congress ought to take a moment and reflect upon the import of
these capital control provisions as a template for future
agreements.
Now, why would Chile and Singapore, as I say, two orthodox
exemplary sets of macroeconomic policymakers ask for an
exception? I think it is because of the cumulative effect of
not just the Asia crisis, but the Mexico crisis, and what they
have observed over the last decade in an increasingly
globalized and sometimes turbulent financial system. They want
to retain the capacity, in an emergency, to do something that
they otherwise have no intention of doing. The International
Monetary Fund, which was certainly a proponent of full capital
account liberalization as recently as seven or eight years ago,
has just released a very careful study which shows how nuanced
one has to be in determining when and how capital flows are
going to be efficient and effective in developing economies.
Why is it that capital flows do not have the effect in a
developing economy that they do in the United States, where
more or less untrammeled capital flows are indeed productive? I
think it is because we are in that murky realm which economists
call the world of second-best. Developing countries do not have
deep and liquid capital markets, by and large. They do not have
well regulated securities markets. They do not, by and large,
have sophisticated supervision for their banking systems. For
all of these reasons, the countries are not able to absorb
capital flows, particularly shorter term debt flows, in the way
that the United States or the United Kingdom could. That is the
reason why Chile and Singapore want this insurance policy, and
that is the reason why I think we need to pay heed to their
policymakers, speaking for themselves and on behalf of other
developing countries.
What troubles me about the present template is that it is
really quite absolutist. It really does not distinguish, as Dr.
Henry is trying to do, among different kinds of capital flows.
Indeed, I note that the investment chapter of the Singapore
agreement mentions and includes as an ``investment'' bonds,
debentures, other debt instruments and loans. Unlike the NAFTA,
for example, it does not say such bonds, debentures, debt
instruments and loans of longer than three years duration. It
is any such bond, debenture, debt instrument or loan. That kind
of painting with a broad brush seems to me not to incorporate
the appropriate modesty that we all must have in assessing the
operation of global financial systems in developing countries
in the wake of all we have seen in the last decade.
I am concerned that what we are witnessing here is a bit of
a triumph of economic creed over economic evidence. What I
would like to see is more of what Dr. Henry and others are
doing, of trying to draw distinctions, to see how much we can
learn, and then through appropriate channels such as the IMF
and discussions in the G-7, to see if we can come up with a set
of sensible nuanced standards--standards that are not just
based upon the textbook finance that apply in the United
States, but that are based on the real operation of capital
markets in the murky second-best world of developing countries.
I do absolutely believe that when the United States enters
into trade agreements, it ought to be doing so with its self-
interest in mind. But that self-interest needs to be an
enlightened self-interest. By ``enlightened'' I mean that we
promote rules which are going to redound to the benefit of all
of our trading partners, which will produce a more growth-
oriented, stable international economy in which the exports of
the members of the coalitions represented by the gentlemen on
my flanks today will be able to prosper. I do not think we have
an interest in some sort of short-term asset grab, if it is at
the cost of our ability to promote such sensible rules.
Thank you very much, Mr. Chairman.
[The prepared statement of Daniel K. Tarullo can be found
on page 177 in the appendix.]
Mr. Feeney. Thank you.
Mr. Vastine?
STATEMENT OF J. ROBERT VASTINE, PRESIDENT, COALITION OF SERVICE
INDUSTRIES
Mr. Vastine. Thank you very much, Mr. Chairman. I am here
to testify on the commercial advantages of the Singapore and
Chile agreements, and explain why they should be approved by
the Congress.
U.S. financial services companies are committed to trade
negotiations to remove barriers to trade and investment. In any
form, these barriers are very extensive. We would be glad to
supply lists by countries of the kinds of barriers our
companies face. The industry's $6.3 billion trade balance in
cross-border trade in financial services last year would grow
if we could remove these barriers. Indeed, reducing barriers to
U.S. services trade is our best hope to reduce the chronic
goods trade deficit that Congressman Sanders has referred to.
Indeed, in order to try to add some light to the statistics
raised earlier by Mr. Saunders, there were 20 million new
services jobs created in our economy between 1992 and 2002.
That more than offset the loss of manufacturing jobs. It is not
correct to think that those jobs are low-paid, poor jobs. In
fact, there are some, of course, as there are in manufacturing,
low-paid jobs in services. But the average annual earnings in
services in 1999, which is the last year for which we have
data, were $32,800 compared to $32,400 in manufacturing. So it
is not true that services jobs in general on the whole are low-
paying jobs. Just to add one more statistic, between 1990 and
2001, U.S. total employment increased from 92 million to 115
million in the private sector. That is not the evidence of a
country that is being laid waste by its foreign trade policies.
Singapore and the Chile agreements, to go back to the
subject, deal with the trade agenda of financial services
companies more thoroughly than any other trade agreement to
date. The Singapore and Chile markets are small, but the
agreements are important precedents. They should be approved by
Congress because, first, they fulfill the negotiating
objectives of the TPA Act. Secondly, they bind liberalization
already adopted by the two countries. Thirdly, they make
commitments to new liberalization. For example, the provisions
in the Singapore agreement on banking give U.S. banks
significant new rights to operate as qualified full banks in
Singapore, and to create and join ATM networks. They include
commitments to cross-border services trade in insurance. Both
agreements allow U.S. companies to offer many more products
such as reinsurance auxiliary services, including actuarial and
other consulting services, marine aviation and transport cross-
border, and brokerage services.
They provide for freedom of financial information flows for
firms like Reuters. They contain important commitments to
freedom of establishment, that is to say direct investment. You
cannot sell a life insurance policy to a Singaporean from an
office in New York. You have to establish. As Mr. Lackritz said
earlier, services trade is characterized by this need to
establish, to enter a market, to set up your business, and to
sell a product. This creates, as in the case of New York Life
in India, a lot of new jobs in New York and elsewhere in our
country. It supports the home offices of our companies.
Next, the agreements contain extensive commitments to
transparency, which are very, very helpful--indeed, a
breakthrough. They contain new provisions for improved
regulatory quality. They provide modest provisions, but
important ones, for the movement of people for temporary
foreign assignments, which is a very important way in which
financial services are traded. Finally, the agreements have
sound investment chapters, which include of course commitments
to freedom of capital transfers. We join the Securities
Industry Association in noting that the agreements have
measures to compensate private investors in case a country
controls capital movements. I would just like to point out that
these measures can backfire against the country that wants
them. Countries that reserve the right to use controls may risk
chilling the investment climate to their own disadvantage. It
is like putting up a sign on the highway into town, ``investors
are welcome, but we reserve the right to keep your cash.''
Finally, Mr. Chairman, we believe these agreements are in
our national interest and the Congress should approve them.
They fulfill the TPA negotiating objectives. They are the
result of substantial industry consultation. They contain some
real breakthroughs, like in transparency. They are good
precedents for FTAs with larger economies. They can seriously
increase our financial services trade, especially if broadened
among other countries, and increase U.S. jobs and prosperity.
Finally, they can help reduce the goods trade deficit.
Thank you very much.
[The prepared statement of J. Robert Vastine can be found
on page 198 in the appendix.]
Mr. Feeney. And thank you.
Congressman Frank, if it is all right with you, why don't
you take about 10 minutes and then I will defer to you, and
then I will conclude if we still have some time and interest.
Mr. Frank. Thank you, Mr. Chairman. I appreciate this.
Let me say, I was pleased to hear Mr. Vastine say that this
goes much further in terms of accommodating the prudential
interests than any previous treaty. I think that is a far more
accurate description than Mr. Taylor saying, oh, it is just
what we have always been doing. I think Mr. Taylor
significantly understates the difference.
I was particularly interested in Professor Henry's
distinction. I welcomed it, with regard to debt versus equity.
To some extent, I think that they are overlapping categories.
There are short-term, long-term. There is foreign direct
investment in portfolio and there is debt and equity. They have
substantial overlap. What strikes me, Professor Henry, is that
the interesting thing about these provisions is they do not
make that distinction that you so carefully made. I wonder if
you would care to comment on whether or not when we do this, we
ought to take those fundamental differences into account.
Mr. Henry. One of the reasons that I wanted to point that
out was actually when I read through the agreement myself, the
chapter on investment, it struck me that there were two
separate issues. One issue is to what extent do you actually
require a country to open up to various kinds of investment,
and that issue does not seem to be addressed at all in the
current investment agreement. What the current investment
agreement addresses is really the second issue, which is given
the decision to open up to certain kinds of investment, how do
you treat foreign versus domestic holders of a given asset? The
point that I just wanted to make, just so it would be on the
record and people can think about it, is that I think the first
point, the extent to which we actually require or possibly
inadvertently push countries to open up to certain kinds of
investment prematurely, is something that we should move away
from.
Mr. Frank. And again, the problem I think many of us have
with these sets of treaties is that they do not make those
distinctions. There were things--nondiscrimination, national
treatment--a number of these things--access to ATMS--which are
very good things. The point that Professor Bhagwati made, who
has been a very strong support of free trade, is that the
danger here is that this will undercut precisely the kind of
support for trade that we wanted.
Mr. Tarullo, one other point you noted, because again Mr.
Taylor keeps saying this is just more of the same, you noted
that with regard to NAFTA I think it was, there was a three-
year requirement that is not here in this treaty. Is that
correct, with regard to bonds, et cetera?
Mr. Tarullo. Congressman Frank, there are a number of
differences between the NAFTA provisions covering investments
and those in the Singapore agreement. I am not able to get a
copy of the Chile agreement. Apparently the Administration has
not formally released it, but I gather it is pretty much the
same. The one difference I mentioned in my testimony, which is
that the definition of investment in NAFTA covers debentures,
bonds, other debt instruments which are of longer than three
years duration. Obviously, that was distinguishing between
shorter and longer term. Another point of difference is----
Mr. Frank. And here there is no such distinction.
Mr. Tarullo. Not that I am able to find, sir. No.
Mr. Frank. I was told there is not, that there is no short
term, long term, or any other kind of distinction.
Mr. Tarullo. The second point--there are a number of
distinctions; we do not want to go through all of them here--
but a second distinction is that the NAFTA explicitly
incorporates IMF standards. Whereas, this agreement, at least
with respect to the investor-state dispute settlement, seems--
--
Mr. Frank. And the IMF does allow for certain kinds of
exceptions.
Professor Bhagwati, I want to go back again to the
experiences that we have had, because again I know no one is
arguing for a regular reliance on capital controls. But would
you talk some more? We have had some dispute about the East
Asia experience in particular. Would you just talk a little bit
more about what we learned from East Asia about particularly
short term, hot money, portfolio investment, and how it is
covered in this treaty?
Mr. Bhagwati. Just to keep matters short, I think there is
a diversity of experience there. South Korea was sort of caught
up by the flu that came from Indonesia and Thailand. Thailand
was a little weaker than Indonesia was, but essentially I think
what happened was that despite relatively strong fundamentals
compared to, say, Mexico or South American countries, these
countries suddenly experienced massive out-flows. So it was in
fact panic. Now, in economic theory, we do recognize that even
when you are strong, you can have panic withdrawals simply
because of things like what we economists call in jargon
asymmetric information and so on. There are lots and lots of
reasons why one could have this. DeRosa would have probably
learned this as destabilizing speculation at Chicago, but it
does occur. This is certainly did occur.
So it had nothing to do with mismanagement or something
like you had, you know, tremendous excess spending, the kind of
thing which broke out in Mexico in 1994. So in that sense, it
was really I think a classic case where you really learned that
systems could in fact collapse under this kind of regime. So I
think that is one lesson that we have learned. So we should no
be too complacent, Congressman.
Mr. Frank. Thank you. I would just note, I understand there
are legitimate differences here. But to impose one particular
view of what is at best a very hotly disputed thing, and to
tell other governments that the price of dealing with the
American market on these terms is to acquiesce to it seems to
me a mistake.
I have one final question for Mr. Lackritz and Mr. Vastine.
We tend to get involved in two ways here. One, we negotiate
treaties as to what kind of investments go, but when countries
get into trouble and are not able to pay off either through
sovereign debt or through other kinds of debt, our government
also gets involved. Does this preference for a complete laissez
faire, free trade, pure let the market work approach apply to
when the trouble starts? Should we be equally saying, okay, the
United States will run interference for you, and we will create
for you absolutely open areas to invest in any of these
countries. However, if having done that, you get into any kind
of trouble and there are not payments et cetera, you are on
your own. Should that be part of the deal, Mr. Lackritz?
Mr. Lackritz. Well, I think you are referring to sort of
sovereign debt restructuring.
Mr. Frank. No, I am referring to--no, there are other
things. There is sovereign debt restructuring. There is the
United States lending money. There is pressure on the IMF. You
know, there are a whole range of things, not sovereign debt
restructuring only. I am talking about whether or not the
United States Treasury, whether it is Argentina or Mexico or
any other country, ought to get involved and say, alright,
let's get involved and let's try and increase the flow of
funds, partly so that the American investors can get their
money back out.
Mr. Lackritz. First of all, I think that what you are
talking about, first of all, we favor having private
contractual mechanisms to work out these kinds of situations.
Mr. Frank. So you do not want any United States government
involvement?
Mr. Lackritz. And the involvement of the government
obviously is helpful in those circumstances, but----
Mr. Frank. But you would be opposed to it as an
interference with the free market?
Mr. Lackritz. I was not saying----
Mr. Frank. You want the right to go in unimpeded. If you
want to go in on your own, shouldn't you stay on your own once
you are in there?
[Laughter.]
Mr. Lackritz. Well, conditions change, as you know.
Mr. Frank. Oh, yes, once you have your money in there, they
change.
[Laughter.]
Mr. Lackritz. I think you have to look at this from a
longer-term perspective, from the standpoint of, how do we
improve the flows of capital.
Mr. Frank. No, that is a separate issue. I understand that.
But I really will be honest, you know, Mr. Tarullo said there
is a question of a creed intervening here. Let's put it on the
table, there is also a question of whether greed is
intervening. Obviously, people have a right to pursue their own
interest, but I do not think it is in America's interest, by
the way, to gain every short-term advantage for every
commercial interest. We have an interest in stability. We have
an interest in democracy. And the question is, frankly, are you
not being inconsistent in being free-marketers when it comes to
put the money in, but somewhat more mercantilist when it comes
to you getting it out? Mr. Vastine?
Mr. Vastine. I do want to respond to something you said
earlier, characterizing my statement that these agreements gave
more attention to financial services and other services, all
other tradable services than previous agreements. Listen, the
capital transfers provision of these agreements is a very small
element.
Mr. Frank. Could you get back to the question? I was just
trying to say that you and I agreed that this is more different
than previous ones than Mr. Taylor says. But what about the
differential standards on the money going in and the money
coming out?
Mr. Vastine. Well, the market should be encouraged to work.
Countries should be encouraged to take fundamental steps, not
surface, not arbitrary, not administrative steps, to try to
cure their international payments problems. Those are the real
cures.
Mr. Frank. I understand that, and that is a good answer if
somebody asked you that question. But the question I had was,
when you have taken advantage of these treaties and freely
invested short-term, long-term, and trouble comes up, should I
not just say, well, I will be interested to watch that because,
you know, you took advantage of the market and the market has
its bumps and its ups and its downs.
Mr. Vastine. And some Treasuries take that point of view.
Mr. Frank. What do you want them to take? I understand
that, but what would your position be? Would you say to the
Treasury, please, let's not be inconsistent here; the free
market should work and we went in eyes open and we knew what we
were getting into; let's not hear any talk of bailouts or
federal government pressures for restructuring.
Mr. Vastine. That is why this agreement provides a
mechanism. If flows are stopped, the agreement does indeed
provide a mechanism, a rather complex one and somewhat delayed
one, to make investors whole. So in theory, there would not be
any need for the government to involve itself.
Mr. Frank. Unfortunately, the way to make investors whole
would be, and I think this is a point that others have made--
Mr. Tarullo and others--it would make investors whole by taking
from a fairly poor country money that would otherwise be
available for some basic services.
Mr. Lackritz. Could I just respond to that?
Mr. Feeney. Why don't we let Mr. Lackritz and Mr. Vastine,
and then we are going to go the gentleman from Illinois.
Mr. Lackritz. Thank you, Mr. Chairman.
Mr. Feeney. Mr. Lackritz?
Mr. Lackritz. I think the point that you are raising,
Congressman, is an excellent point, but I would only refer you
back to Emerson's notion that a foolish consistency is the
hobgoblin of small minds. That is why we are trying to be
pragmatic and practical here as well.
Mr. Vastine. I guess my last point, Congressman, is that I
cannot quote Emerson. I could give you a little Mark Twain on
``lies, damned lives, and statistics,'' but I will not do that.
I would just like to caution that we should not be cavalier or
presumptuous in thinking that the Chileans and the Singaporeans
have weak regulation, and are not sophisticated negotiators.
They are very sophisticated.
Mr. Frank. I agree. One second here, I just want to say to
Mr. Lackritz, to modify another quote, reference to Emerson in
that sort of a situation is the last refuge of people who do
not have a logical answer for an inconsistency.
Mr. Feeney. Well, I thought we were talking to economists.
We expect some inconsistencies, don't we?
The gentleman from Illinois.
Mr. Manzullo. I have a son studying English and poetry and
Grove City, and he fell in with the libertarians and now he
wants to double major in economics, so he can quote Emerson
along with the economists.
First of all, I am sorry I could not listen to the
testimony of everybody, but it really ties into the
constituents I have back there. There is a very skeptical mood
in Congress with regard to any new free trade agreements, based
upon the fact that there are not empirical studies that can
justify economic theories. Members of Congress are elected by
real constituencies, and not theorists.
Let me give you an example. We have got a huge war going on
with massive waivers of the Berry amendment by the Secretary of
the Air Force, that is allowing Russian titanium to go into
engines on our military aircraft. The waivers are granted ex
parte. There is no notice. These are strategic metals, and
therefore in the area of procurement. As a person who calls
himself a free trader, we have looked upon the $300 billion in
procurement in this country as a way of leveling the playing
field. In other words, if the local manufacturers can get
contracts for U.S. consumption, paid for by U.S. taxpayers'
dollars, then that is the way to get a good share and to
maintain a base, especially in the area of strategic metals.
In examining these free trade agreements of America, the
new FTAA, the Singapore and the Chilean agreements, our U.S.
procurement is opened to these countries, and they can
manufacture goods obviously a lot cheaper than our people, by
providing nondiscriminatory treatment. In other words, if
somebody from Chile wants to make a tank tread or tank turret,
they can come in, bypass the Berry amendment, and again add to
the hollowing out of manufacturing that is going on. I asked
one of the assistant USTRs, and I have tremendous respect for
Bob Zoellick. I do not think he is a Leninist, Dr. Bhagwati,
even though the theory may have been Leninist. I am just
teasing you, you know that.
But I said, do you have any quantitative evidence as to who
wins and who loses when we open U.S. procurement to foreign
countries? In other words, are there any documents out there
that show how much U.S. companies are buying of procurement
from other countries, and how much other countries are buying
of procurement from the United States. I was told the
statistics do not exist. If the statistics do not exist, then
why do we proceed with going ahead with these new agreements
that leave the procurement open and further hollow away at our
manufacturing base in the United States? I know this is on
services and services are extremely important because the more
liberalization of services you have, the merchandise follows
after that. That is after the Vastinian theory put forth in a
Cato article that Mr. Vastine published about three years ago,
and that is when we first got involved in this. Does anybody
want to tackle that question, take a look at it? Professor, I
know you would like to.
Mr. Bhagwati. I do not know of any empirical studies
because procurement has usually been for one's own people, so
that you would have to have an anticipatory study--you know,
what would happen if, which would be very problematic. But I
think I would just sort of make one response to this. This is a
matter of opening up your system to more trade, just like the
rest of the system. Procurement has been usually, even in the
Uruguay Round agreement, I mean, that was kind of optional for
most countries, I think, who signed onto it. But it is not in
the regular agreement. It is on the annex.
I would simply say that as more countries do that--I mean,
obviously we are not going to get much out of these two partner
countries in an FTA, but as we open it up and make procurement
open to everybody around the world, and in the major countries,
we will gain as much as we give, even looking at it on the
terms in which you specify.
Mr. Manzullo. But that is theoretical. You do not have
any----
Mr. Bhagwati. Well, we are pretty competitive, Congressman,
so I would say we would expect to win a fair amount.
Mr. Manzullo. But if that is the case, then the Chinese
could come in and make all of our aircraft. They could make
everything for us at a cheaper cost. Currently, if a document
is shipped from the United States, with the exception of
something that is bonded going to Mexico, because we know it is
coming back, and with the exception of the 62.5 percent, NAFTA
content in automobiles, we have no way of knowing how much
foreign content exists is in an item that is shipped as a U.S.
export. We have to study that because, you know, I lost 10,000
manufacturing jobs in the congressional district that I
represent in the past two years. So has the Speaker. His
district is the mirror image of mine. Rockford, Illinois, which
is in the center of the congressional district I represent, led
the nation in unemployment in 1981 at 24.9 percent. And now, it
is pushing 11 percent and we are losing more and more
manufacturing jobs. These jobs are not coming back. So we are
taking a look again at free trade being fair trade, and we are
trying to make sure that what is touted as something that is
made in America actually has American parts.
If I may indulge the chair for a minute or so.
Mr. Feeney. How about you take another two minutes?
Mr. Manzullo. Okay. Thank you very much.
In October of 2002, the Congress passed a bill that would
authorize Boeing aircraft to lease to the United States 100
767s, retrofitted as KC-135s, which are the fuelers that haul
the fuel. Included in that legislative language, was a Berry
waiver. I have scheduled an April 30th hearing on this before
the Small Business Committee. I have held a meeting with the
principals of this hearing this past week, along with Duncan
Hunter from the Armed Services Committee. The question became,
this is a noncompetitive contract; it is done by the grace of
the U.S. Congress to help out Boeing aircraft. At the same
time, with all the Berry waivers in there, we do not even know
how much of that aircraft would be U.S.-content. In fact, Pratt
and Whitney were at that meeting, and on the military aircraft
they are selling, not only is there Russian titanium, but the
drive shafts are made of nickel coming from Japan. Nickel is
also a strategic metal that is covered under the Berry
amendment.
The reason I bring this up is the fact that, and I know you
are testifying on services, and services are critical, and
those who are not free traders in service do not understand
that unless the service industry gets way out front, it is the
service industry that pulls the manufacturing component behind
it--so I know that you all have different views on this, but I
accept that basic theory. Bob Vastine, you have been a real
mentor to me on that, and Professor, I have read your stuff. I
will read the testimony of each of you. But if anybody has
anything they want to send me with regard to that, please do
not send it through the mail. Call our office, and we will give
you the fax number.
Mr. Bhagwati. I would be glad to do that.
Mr. Manzullo. And thank you very much for giving me the
additional time.
Mr. Feeney. Thank you. Obviously, this is a very important
issue to Mr. Manzullo and his constituents. If any of our
distinguished panel has anything that they can assist him with,
I am sure he would be grateful and so would the committee.
I just have one or two questions before we wrap up and let
everybody go for lunch. First of all, I want to make sure that
there are six other people that are engaged in the same premise
I am, and that is that in general, with some exceptions, Adam
Smith was right and free trade is best for both parties
involved. Does anybody want to raise their hand?
Mr. DeRosa. Absolutely.
Mr. Feeney. Mr. DeRosa, maybe you can start, then, if we
all start with the same basic premise, it seems to me that the
history of both undeveloped, developing and highly developed
countries is based on a couple of things--certainly being at
peace is helpful--but in terms of things that you can help
internally with respect to domestic policy. They are prudent
monetary policy; respect for the rule of law; respect for
property rights, both real and intellectual; relatively low
marginal tax rates; and transparency in terms of the way the
country does business. These help generate prosperity within a
country, but is it also true to say that those policies attract
capital? That is part one.
And then number two, and then I will open it up for some
other folks to respond, with respect to this question about
basically restricting or freezing capital. This is part two of
the question. Surely, regardless of whether you come down as an
absolutist, that it should never be done or allowed in these
particular trade permits, or whether we should always allow
countries free rein, surely most of the panel will agree that
there is going to be a risk associated with investment in
nations that can essentially restrict, or at least temporarily
nationalize capital.
And so going to Dr. Henry's distinction, which is sort of
the moderate position as I review the testimony, can you attack
the problem based on Dr. Henry's testimony? If I want to create
a widget manufacturing plant and invest $100 million, am I more
or less likely to invest in a country that is prone or able
under a trade agreement to nationalize the $100 million
investment in my manufacturing plant? And if I am less likely,
and I assume we all agree that I am less likely to make that
investment, why would we in terms of incentives for investors,
because after all capital is the most liquid and the most
morally neutral thing I know of, why would we be more likely to
disincentivize investors on the debt area, as opposed to the
equity area? Maybe Dr. DeRosa, you can start.
Mr. DeRosa. Thank you. The reason that these countries that
we speak of got in trouble was not necessarily a distinction
between debt and equity, but the denomination of the financing.
But they did get in further trouble by using excessive amounts
of short-term debt, so when the crunch hit, they could not find
investors to roll the debt. The reason why this enthusiasm for
short-term debt--it is an interesting question, because I
indicated earlier that in every one of these cases, you can
trace back almost signature errors that governments did in
responding. In the case of at least Thailand and South Korea,
and I think other ones as well, but I know in those cases,
there were government policies before the crisis to force or
greatly encourage local companies to borrow short term and
never long term. The title for this, the name for this is
called window guidance. Thailand had effectively had a
government institution set up to encourage companies that
borrow internationally only to borrow short term. The same was
for Korea.
So it is a combination of a squeeze on the currency and
also a squeeze on the denomination. But your characterization
of what it takes for growth is something that I have great
sympathy for. These are things that actually are in Adam
Smith's Wealth of Nations, about what is the proper role of the
government in terms of the rule of law, property rights, things
like that. Essentially, that is what went wrong in the early
stages after the Soviet Union disintegrated. Why didn't growth
come earlier? But I come back to this basic premise that
capital really is not as fickle----
Mr. Feeney. Well, and in Latin America, agrarian reforms do
not help if every new regime every three years nationalizes
property and institutes a new set of reforms.
Mr. DeRosa. Absolutely. And this is what is going on
wholesale in Venezuela right now. This is why a country that
ought to be prosperous is in a tailspin thanks to the leader of
Venezuela. But you know, it all comes back to this. There is
this central thing that I keep saying to people. Capital really
is not as flighty as people think. The hot money that people
describe, thinking that it is going to rush in and rush out,
every case that I know of, and I have studied all of these
crises in detail; I wrote a book on this; I write columns about
this. It is all associated with the nature of the foreign
exchange regime. It is always traceable back to a fixed or a
creeping fixed exchange rate regime. People are trying to game
the system. The locals are borrowing in dollars because dollar
interest rates are lower by definition because of country risk.
Foreigners are investing in the local currency, and sometimes
on a leverage basis.
When the situation becomes untenable, then when the
exchange rate regime goes to break, that is when you get this
massive outflow of capital. Once the exchange rate starts to
float again, this phenomenon does not--I do not know of a
single case; I have studied a lot of economic history, have
written a lot about economic history--all of these things are
coming out of the exchange rate regime. That is why the crises
occur. No country that I know of has gone from a fixed exchange
rate regime to a floating regime in the last 20 years and
suffered a second crisis. So all this talk about putting in
capital controls is irrelevant and damaging, because it is
unnecessary. It is unnecessary. Countries do not just fall over
dead in their tracks. They do not just roll over and collapse.
That is not the nature of modern economics as we know it. You
can always dissect it. You can always do a post-mortem and in
all of these cases that we are talking about, where capital
flight is a problem, go back and look at it carefully and you
will see it is coming out of the disintegration of a pegged or
fixed exchange rate regime.
Mr. Feeney. Thank you, because it would be a waste of some
superior intellect and talent to speak at length to a freshman
Congressman from Florida, if each of you will take two
minutes--Dr. Bhagwati, and then maybe we will skip Dr. DeRosa--
thank you for your lengthy--and maybe we will just conclude and
thank you for your participation.
Dr. Bhagwati?
Mr. Bhagwati. Thank you, Congressman. Just to respond to
your last question very briefly, what we are dealing with is
the ability to use capital controls in a crisis and what the
consequences would be. I think to treat that as something like
confiscation. I do not think that is what the gentlemen who are
going to invest are going to look at it that way. I think the
probabilities are on the low side. What we are saying is you
have to allow for it and let these countries really be able to
exercise this option. I do not think anybody is going to be
affected by that in terms of investing in one country rather
than another. So I think it is, my answer to you is, well, the
threat of nationalization, et cetera, of course it is something
we would all react to. We would not want to put money there.
That is not what we are dealing with. So I would say relax on
that one and take this out if you can.
Mr. Feeney. Thank you.
Dr. Henry?
Mr. Henry. Let me start by saying that free trade is one of
the best means we have for actually increasing global welfare,
so we should almost always in all circumstances continue to
push for free trade on a fair basis. With respect to free trade
in capital, by and large free trade in capital also has the
potential for the same kinds of effects. Where we need to be
careful is when we are dealing with systems in which there are
other distortions, for example a fixed exchange rate regime, as
Dr. DeRosa mentioned. In those circumstances, we want to be
careful about inadvertently pushing countries into undertaking
policies which, given those other distortions in the system,
could prove very damaging in certain kinds of situations.
So for example, if you have a fixed exchange rate system
and people are tempted to borrow in dollars because interest
rates are low, what we have seen time and time again is that
the people who actually borrow in dollars are people who are
not actually earning dollar revenues, and that creates a real,
very explosive situation when in fact the exchange rate regime
comes to an end. So what we should do in those situations is
really force people to internalize those risks and recognize
that in certain situations where there are obviously other
distortions, the first best policy--complete free trade in
capital--might not be the best answer. In particular, since
history has shown us empirically that these debt market
liberalizations seem to get countries in trouble, we should
just be very wary of that.
In general, I agree with your point. Anything which creates
a disincentive to capital to go into a country is going to lead
to less investment. But we should remember that what we want is
efficient investment, not just investment.
Mr. Feeney. Or higher interest rates or expectations of
return on capital.
Mr. Henry. That is right, but sometimes higher interest
rates or implicit interest rates are in fact warranted because
there are risks involved. We should in general move to a
situation that is efficient, to use an economist's term, ex
ante--before things happen--where we get people to actually
internalize those risks and generate efficient investment.
Mr. Feeney. Thank you, doctor.
Dr. Lackritz?
Mr. Lackritz. Thank you. I appreciate the upgrade in my
degree.
I think going to your point, Congressman, that obviously
capital flows to countries which have institutions where there
is the rule of law, where there is an openness and a
transparency, and where there is a culture and a tradition of
where there is an expectation of returns. At the same time, the
market is fairly efficient, and where these institutions do not
exist, obviously the rate of return has to be higher to attract
the capital to reflect the added risk that is involved. I think
one of the benefits of these kinds of free trade agreements is
that they open up markets more to promote more capital flows
back and forth from country to country, and more flows of goods
and services, which of course the financing is accompanying.
That is why the capital flows are going back and forth as well.
So these agreements actually are a good start, which help
other countries to see what they need to do to attract capital.
They see the results from the standpoint of the marketplace and
the rate of their own development, which is a very powerful
incentive for them to open up and to create these institutions.
Mr. Feeney. Thank you.
Mr. Tarullo?
Mr. Tarullo. Thank you, Mr. Chairman.
Mr. Chairman, I will end where I began, which is urging
some sense of modesty in this area. We are all experts in
retrospect. We look back at the Asia financial crisis, and we
say, aha, that is what happened. But if we are honest with
ourselves and go back eight or ten years, so far as I am aware
the people at this table and the people elsewhere were not
identifying some of the problems which we now in retrospect see
were very important. I have no doubt but that the next
financial crisis, when it comes, will contain elements of
traditional financial vulnerabilities and will contain
something new, that will be a surprise, and that will give more
fodder for scholarly and policy work thereafter.
I think the reason why some of us are concerned with the
capital controls provisions is not because we want to go
proselytizing for capital controls. I think Dr. Bhagwati and I
have tried to make that clear in our own approaches to this
issue. We believe we need to understand this more, we need to
understand where and how problems may arise, and we need to
have a system prepared that will allow countries to respond if
the worst happens. My own sense is that if Singapore and Chile
are concerned about not having this fallback position, then
other countries with even less well-developed capital markets
and regulatory systems are even less well developed, will be
more concerned. I do not think we want to push them down that
road. I think what we want to help them to do is to build the
institutions that will make for strong securities markets and
strong bank regulatory systems, and then see what benefits the
free flows of capital can bring.
Thank you very much.
Mr. Feeney. Thank you.
And finally, Mr. Vastine, you can sum up.
Mr. Vastine. Thank you very much, Mr. Chairman.
First of all, these are good agreements. They contain a
great deal more than the capital issues. Congress should adopt
these agreements. Chile and Singapore freely agreed to these
provisions. I was familiar with these negotiations. No one held
a gun to their heads. They are very sophisticated negotiators.
They are very good regulators.
Finally, I do not think the objections raised today give
grounds to the committee or to other members of Congress not to
vote for these agreements.
Thank you.
Mr. Feeney. I want to thank all of you. We will get you out
for a late lunch. The chair would like to thank all of you for
traveling and being here with us today. Without objection, the
record of today's hearing will remain open for 30 days to
receive additional material from members and supplementary
written responses from witnesses to any question posed by a
member on the panel.
The hearing of the Domestic and International Monetary
Policy Subcommittee is hereby adjourned.
[Whereupon, at 12:35 p.m., the subcommittee was adjourned.]
A P P E N D I X
April 1, 2003
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