My views on foreign policy

Many commenters have great difficulty understanding my views on foreign policy.  I presume this is because many (most?) commenters think this way:   “Sumner said X.  People who say X usually believe Y.  Therefore Sumner thinks Y”.  That might work for most people, but it doesn’t work for me.  Actually, my views on foreign policy are boringly conventional and quite moderate:

1. Some of my commenters accuse me of being a bloodthirsty warmonger, because I support NATO.  I.e., I think we should go to war against Russia if they invade Estonia.  I also think we should go to war against China if they invade Japan or Australia, due to our defense treaties with Pacific powers.  I like mutual defense treaties among countries that have their act together.  AFAIK, it’s the only “foreign policy” that seems to consistently work.  They are one of humanity’s greatest achievements.

2. Another group of commenters think I’m a lily-livered, Neville Chamberlain appeaser, because I don’t wish to go to war against China over Taiwan or Xinjiang.

3.  Another group thinks I don’t care about human rights abuses in foreign countries, even though I passionately care about human rights abuses in foreign countries—far more than 90% of Americans, and infinitely more than Trump—who is quite upfront about not caring at all.  Reading about the Rohingyas and the Yazidis literally brings tears to my eyes.  I care so much about foreigners that other commenters say I’m not patriotic enough, putting the interests of the most oppressed people in the developing world ahead of red-blooded Americans.  I can’t win.

4.  Another group claims I don’t believe that distinct regions should be free to secede from larger entities, even though I’ve expressed support for peaceful examples of secession, as with the Czechoslovakia.  They confuse my statements about the current agreed upon rules of international law (no secession without consent) with my personal views as to what sort of world would be best.  My claim that Taiwan would be foolish to secede from China without their permission, thereby triggering a horrific war, makes me a Chinese apologist in their view.  Taiwan already has all the advantages of de facto independence, and is fortunately too smart to take the advice of my rash commenters (safely out of harms way) and commit mass suicide by seceding. While I have no problem with the idea of an independent Taiwan achieved peacefully with Beijing’s consent, the US should tell Taiwan “If you formally secede, you’re on your own.”  I’d guess we already have.  And in any case, Taiwan is currently doing fine.  If it ain’t broke, don’t fix it.

Are there other occasions where you might want to use military force, beyond mutual defense treaties?  As a utilitarian I cannot say there are no circumstances where military force is appropriate, but I’m generally almost as skeptical as Bryan Caplan.  Perhaps military force should be used to stop extreme human rights abuses like genocide.  But how many now favor a US invasion of Myanmar, where the government is massacring the Rohingyas?  There are enormous practical problems with that policy option. Saddam Hussein had an appalling record in many different dimensions, and indeed in 2003 I thought there was a pretty good utilitarian case for getting rid of him.  (I wrongly assumed a quick war like the 1991 Gulf War.)  The 2003 Iraq War obviously turned out to be a disaster, and this has helped to shape my views on foreign policy.

I’m now more skeptical of the hawks than before.  History is full of examples where the hawkish stance turned out to be a complete disaster (1914, Vietnam, Iraq War, etc.)  Even cases where we had a quick victory (Spanish-American War) look like clear mistakes in retrospect.  People often point to 1938 as an example of the doves being wrong.  But even there, a hawkish stance by Chamberlain would have merely triggered the “Phony War” portion of WWII a year earlier, resulting in a less clear cut historical record that the Nazis were 100% the aggressors.  Would you want a modern Germany full of Germans who feel that Germany was picked on twice?  So I still say we should use the military primarily for self (or mutual) defense, and any other use should be exceedingly rare. Countries allowed into mutual defense pacts should be free of ongoing border disputes.

There’s a better case for using economic sanctions as a foreign policy tool.  But here again, the historical record is quite unimpressive.  Yes, the sanctions against South Africa may have contributed to the end of apartheid.  But for every success like that there are far more failures, such as the Cuban sanctions.  If you are using sanctions because of human rights abuses in the targeted nation, the goal should be to make the people in the targeted nation better off.  Thus it helps if you have popular support, which seems to have been the case in South Africa (but not Cuba.)

As an example, I’d guess that 98% of the Chinese public would oppose Western economic sanctions.  The Chinese are very nationalistic and intensely feel the humiliation imposed on them by Western powers in the 19th century.  None of that may matter to you, but it will definitely impact the effectiveness of any sanctions that try to force China to change its ways.  US sanctions on China will certainly make the US worse off, and certainly make China worse off in the short run, and definitely make China more prickly and nationalistic.  For that sort of “human rights” policy to pass the utilitarian test you’d need a series of political changes in China that are about as likely as making a 4 bumper shot in billiards.  How’s our previous track record in that regard?  In contrast, economic development usually (not always) improves human rights.  And yes, Xi Jinping is an exception.

I’m particularly amused by my right-wing friends who are outraged by human rights abuses against Muslims in Xinjiang, but are silent about Modi’s record in India. Or Saudi Arabia’s appalling record in Yemen.  Or who had no problem with the US torturing Muslims and imprisoning them without trial. (And no, I’m not saying these abuses were anywhere near as bad–but do you have consistent principles?) Or those conservatives who favor economic sanctions against the Chinese for violating human rights in Xinjiang, but used to complain that sanctions against South Africa under apartheid “hurt the people they were supposed to help”.  (A view I held at the time, but now less certain about.) Unlike many people on both the left and the right, I don’t tailor my views to whether the human rights abuses are committed by a right wing or a left wing government.

A better argument for sanctions is as a deterrent to countries that engage in dangerous military behavior.  Thus sanctions on Russia were appropriate after they conquered part of the Ukraine, and sanctions on China would be appropriate if they attacked Taiwan without provocation.  Perhaps sanctions are appropriate on North Korea; I think that’s a close call.

My views are pretty simple.  We should have defense treaties with like-minded countries to deter aggression.  Otherwise try to avoid going to war.  Trade freely with all nations, except under a few very limited conditions.  I have an open mind as to what sort of military behavior or human rights abuses calls for sanctions, but in general I think the bar should be pretty high.

What about non-military predatory behavior, such as what China is accused of?  First we need to figure out the facts.  The news media has recently reported claims of Chinese spying that turned out to be false.  When there is Chinese spying, or related behavior, it should be handled in the same way we’d handle spying from Russia or some other country.  Tit for tat is fine.  If they punch us, then punch back.  But it’s extremely unlikely that a policy such as 25% tariffs on Chinese goods, which was first developed as a weapon to be used to reduce our trade deficit, would suddenly be the appropriate policy for Chinese human rights abuses in Xinjiang, or Chinese spying on US tech firms.  What sort of tariff should we have on Vietnam, for its severe human rights abuses?  (Vietnam is in many ways the most similar country to China.  A reforming communist East Asian country that is growing fast and still has lots of human rights abuses.)

Some regard China as a military threat to the US, which I think is implausible.  The combined strength of NATO plus Japan, South Korea, Australia and New Zealand towers over anything else on the planet.  These mutual defense pacts are hugely successful and will almost never be attacked by outsiders (except possibly by the accidental launch of nukes or, of course, terrorism.)

To summarize, I’m a utilitarian on foreign policy.  Show me evidence that an alternative plan will make the world a better place, and I’ll support it.  I’m not an ideologue.  But right now the evidence suggests that mutual defense and free trade are generally the best options.

I’m certainly no expert on foreign policy.  But when I read some of my commenters, I feel like most other people are even more clueless than me.

One final point.  Whenever you read a commenter saying,”Sumner believes . . .” you can be pretty confident that I do not in fact believe what comes next.  And when you read, “Because he has a Chinese wife, Sumner believes . . .” LOL.

Update:  I recommend this Edward Luce piece in the FT:

In most professions, such a litany of errors would prompt a soul-searching. Heads would roll. Schools of thought would close down. The magic of Mr Trump is that by uniting the elites in revulsion against his abrasive style, he has restored their sense of moral self-belief. Last month, William Kristol, a leading Never Trumper and Iraq war cheerleader tweeted: “Shouldn’t an important foreign policy goal of the next couple of decades be regime change in China?”

On China, Mr Trump and the blob are ominously coming around to the same view — that it must be confronted. They differ on methods. Mr Trump’s critics would prefer the US to build an allied consensus to win the “new cold war.” They dislike Mr Trump’s bilateral pugilism. They also bemoan his obliviousness. How could he have not known of the arrest of one of China’s business stars on the same day he was negotiating a truce with its president?

Yet they concede that Mr Trump has identified the right target. All of which presages danger. Whenever Mr Trump leaves office, the chances are that the blob will find itself back in the situation room. The story of this young century is a series of US blunders that boosted China’s power far beyond its expectations. It would be odd to hand back control to the people who brought this about.


The Republican Party’s future

Here’s the state of Britain’s right wing party, supposedly being torn apart by Brexit:

Alan Duncan, a junior minister in the Foreign Office, said of the Tory MPs who had triggered the confidence vote: “This is an act of irresponsibility, foolishness and national vandalism.”

“Any attempt to replace the prime minister in the middle of all this is utterly reckless and brainless. Anyone who has done this should be ashamed of themselves. They are not acting in the national interest.”

If Mrs May lost a vote of confidence or decided to resign, it would plunge the party into a formal leadership contest; there is no clear frontrunner to replace her and any contest would be highly divisive and could take weeks to play out.

Now let’s look at the condition of the right wing party in an English-speaking nation facing no Brexit crisis, which has a healthy economy that has been growing for 27 straight years, and no immigration crisis:

Mr Morrison owes his current eminence (if, again, that is the right word) to a cabal of what a senior Liberal calls a bunch of “crazy, right-wing nutjobs”. In August they defenestrated the man, Malcolm Turnbull, who had called and won the previous election, and had attempted to govern as a pro-business and socially liberal centrist. One of the cabal, Peter Dutton, a vituperative populist, failed to secure Mr Turnbull’s crown. In the ensuing scrimmage, which did few of its participants credit, Mr Morrison won it almost by accident. The most competent moderate, Julie Bishop, was swiftly trampled. . . .

In politics, says one senior party member, you used to make progress through compromise. “Now, it’s, ‘If you don’t give me something I want, I’ll blow the place up.’” Perhaps Mr Abbott and his like really do have a death wish. Perhaps they fancy that defeat by the Labor Party will have a wonderfully purgative effect, clearing the wets out of the Liberal Party and allowing their faction to enjoy unadulterated rule. What is nearly certain is that a grand old party faces a whipping next year. The question is whether it can survive at all.

As I keep telling you, there’s something in the water. (Or the internet?) I’m sure that some commenters will say that politics is always like this.  Actually, this is much worse than usual.  I predict that the US Republican party will be torn apart by a similar crisis, at some point in the next few years.

PS.  This also caught my eye in the Australia article:

As if in support, the women’s minister, Kelly O’Dwyer, said in a leaked discussion with colleagues that the party’s leaders were seen as “homophobic, anti-women, climate-change deniers”.

Anti-women? So it’s not just Brazil, the Philippines, the US, Italy, and Russia.  Add Australia to the list of countries featuring increasingly misogynistic leadership.  Is that enough to count as a trend?  Maybe Time’s “Man of the Year” should have been, “The angry, homophobic, misogynist, authoritarian, gas guzzling, macho male.”

PPS.  This made me smile:

“Now, it’s, ‘If you don’t give me something I want, I’ll blow the place up.’”

Trump has said that if Congress doesn’t give him the new Nafta, which is quite similar to the old one, he destroy Nafta entirely.

What should the Dems do?  Feed the beast, or see if Trump is bluffing?


Natural interest rate bleg

I suppose I should know what the natural rate of interest is, given that I’m a monetary economist.  But I see the term used in two radically different ways, and am not sure which version is correct:

1.  The real interest rate that would exist if the economy were at full employment and stable prices (or on-target inflation).

2.  The real interest rate that would be expected to push the economy back to full employment and stable prices (or on-target inflation).

A recent NY Fed piece used the first definition:

The Laubach-Williams (“LW”) and Holston-Laubach-Williams (“HLW”) models provide estimates of the natural rate of interest, or r-star, and related variables. Their approach defines r-star as the real short-term interest rate expected to prevail when an economy is at full strength and inflation is stable.

The accompanying graph shows their estimate of the natural real rate for the US:

Screen Shot 2018-12-10 at 3.22.38 PMObviously, it would have been a disaster if the Fed had set the real rate at that level during the Great Recession.  Rather the authors are showing the real rate that would be appropriate in the counterfactual case where the economy was at full employment.

In contrast, an article by Vasco Cúrdia at the San Francisco Fed uses a very different concept when describing the natural rate:

The natural rate of interest is the real, or inflation-adjusted, interest rate that is consistent with an economy at full employment and with stable inflation. If the real interest rate is above (below) the natural rate then monetary conditions are tight (loose) and are likely to lead to underutilization (over-utilization) of resources and inflation below (above) its target.

At first glance, that sounds similar to the New York Fed’s definition, but he later clarifies that this is the rate expected to lead to full employment, and that the natural rate will fall when the economy is depressed:

During the economic recovery, the natural rate was kept low by weak demand due to a larger propensity to save in the aftermath of the financial crisis.

As a result, Cúrdia’s estimate of the natural rate is dramatically lower than the NY Fed estimate:

Screen Shot 2018-12-10 at 3.28.14 PM

I like Cúrdia’s definition better, and it’s the one I’ve always used.  During the Great Recession, the Fed would have had to initially cut real rates to very low levels to push the economy back to full employment.  But if a magic wand (say a quick adjustment of wages and prices by God) had suddenly gotten us back to full employment, then the equilibrium interest rate would be much higher, as is normally the case during booms.  That’s the NY Fed estimate.

Alternatively, if monetary policy had been expansionary enough to prevent a Great Recession, the natural rate would not have fallen as sharply.

Here’s the problem.  I see each version of the natural rate being used by various economists, and I don’t know which use is conventional.  This makes it hard to communicate with other macroeconomists.

Personally, I don’t like speaking Spanish or Keynesianism. But when speaking with Mexicans I at least try to use a bit of Spanish, and when speaking with Keynesians I at least try to use a bit of Keynesianism.  But if I don’t know the proper meaning of the terms, then it’s hard to communicate.

Can someone please help me?

Cúrdia explains the difference this way:

Williams (2015) estimates the natural rate to be low by historical standards, but not nearly as low as those shown in Figure 1. The main difference is that Williams uses the statistical model of Laubach and Williams (2003), which is better suited to determine the longer-run level of the natural rate. By contrast, my analysis is suited to find short-term fluctuations in the natural rate.

But that doesn’t seem adequate to me; it seems like they are describing entirely different concepts.  And even if it’s correct, it suggests that economists should never refer to the term ‘natural rate of interest’ without first specifying whether it is the short or long run version.  Indeed Cúrdia hints at this inadequacy when describing how one could draw incorrect policy implications from the alternative definition:

This distinction is important in evaluating monetary conditions. In contrast to my results, the interest rate gap using the Laubach-Williams measure of the natural rate has been negative since the recession. According to their estimate, the Fed response to the crisis was expansionary because it lowered the real interest rate below its longer-run natural level.

Obviously, if the natural rate is defined as the rate that would prevail if the economy actually were at full employment, it’s of zero value in determining whether monetary policy is expansionary in an economy that is far from full employment.  So this isn’t just “semantics”, there are important policy issues at stake here.

Nor can the natural rate of interest be described as the appropriate real interest rate on long-term bonds, as that rate will itself depend on the future path of monetary policy.

Update:  Commenter Judge Glock left the following comment, which seems correct to me:

Maybe this isn’t helpful, but I think it just has to do with referring to different parts of the Taylor Rule. For the “long-term” natural rate, people mean the r* as in r* + a1(infl – desired inflation) + a2(output gap – desired output)= i, or, in other words, the intercept of the Taylor Rule, or its equivalent. Other people seem to refer to the natural rate as the final i, the dependent variable of the Taylor Rule, or the output of the equation, which represents the short-term rate when factoring in output and inflation gaps. It may be mere preference or semantics, but it seems to me the i more closely approximates the original Wicksellian understanding of the “natural rate,” or the rate that will keep the economy at equilibrium, while the r* more closely approximates the combination of growth rate and time preference. The confusion, though, could be emerging from the original Laubach-William paper, which, if I’m reading it correctly, estimates the “natural rate” or “r*” by looking at output gaps and real interest rates over time, thus treating the r* as something like the Taylor Rule’s i, even while they also refer to r* as the combination of the economic growth rate and household time preference not dependent on output gaps.

Update#2:  Rayward directed me to an excellent 2015 Tyler Cowen post on the topic.

The increasing populism of the new right

India’s Modi shares some similarities with other populists in places like Turkey, Italy and the US.  Here’s a recent FT story:

Tensions between the RBI and Mr Modi have been mounting for months over the central bank’s hawkish monetary policy, use of its mounting reserves and the tough measures taken to clean up bad loans at India’s state-run banks.

Mr Modi has been accused of demanding that the RBI ease back on its crackdown out of fear it will hit economic growth during his drive for re-election, particularly as liquidity in non-bank lenders has dried up after a series of defaults at IL&FS, a high-profile finance and infrastructure group.

At a 10-hour board meeting last month, Mr Patel made a number of concessions under heavy pressure from government nominees, including promising to review restrictions on fresh lending by banks that already have high levels of bad debt. Pressure on the RBI was expected to continue at Friday’s meeting.

Fresh lending from banks that already have high levels of bad debt?  What could go wrong?

As a result of the pressure, Patel announced his resignation today.  (Recall that Raghuram Rajan was let go two years ago, for similar reasons):

“By forcing Mr Patel’s hand, the government has now made it clear who runs the show,” said Eswar Prasad, a professor at Cornell University, adding that the move marks “the culmination of the government’s taking the hammer to a cherished and widely respected institution”.

The Indian rupee fell more than 1.8 per cent against the dollar in the immediate aftermath of Mr Patel’s resignation.

If you look around the world, there is more and more evidence that the left and right are switching position on a wide range of issues:

1.  The populist right is increasingly supportive of monetary stimulus and opposed to central bank independence. (Easy money)

2.  The right is increasingly supportive of protectionist trade policies. (Mercantilism)

3.  The right is increasingly supportive of ramping up “moral hazard” in the financial system. (Easy credit)

4.  The right is increasingly supportive of deficit spending, including entitlements.

Those used to be left-wing positions.  Of course there are plenty of Republican politicians and pundits in the US that still oppose this populism, but this is the way that politics are evolving, all over the world.

I predict this process will continue, with local variations. Many other left wing ideas will flip to the right. The right will advocate a higher minimum wage and more government spending on infrastructure.  Right wing populists will increasingly oppose Silicon Valley type companies.    But this switch on tech firms will be less noticeable in the US, as it conflicts with the desire of nationalists to extract rents from the rest of the world.  In contrast, populists in the other English speaking nations will be less protectionist than in the US, as the costs of protection are more obvious in those smaller trading nations (Canada, the UK, Australia, New Zealand, Ireland, etc.)

Nonetheless, at a deep psychological level, the forces reshaping politics are obviously global.  The Economist has a fascinating article on the recent dramatic changes in Australia’s (conservative) Liberal Party, in which a Trumpian wing is suddenly becoming far more powerful.  Interestingly, the factors that supposedly led to the rise of Trump in America (opposition to imports, the Great Recession, low-skilled immigration, etc.) are largely absent in Australia.  This suggests that the psychological cause of this phenomenon is far deeper that the shallow explanations offered by media pundits.  I have no idea what those causes are, but imagine they will become clearer over time.  Why is misogyny usually a part of the package, for instance?

The Conservative Party in the UK is going through turmoil very similar to what’s reshaping Australia’s Liberal Party.  Unlike in Australia, however, it stays afloat because its opposition is even more loony.  The Australian Liberal Party doesn’t benefit from such a weak opposition, and thus faces a disaster at the next election.

The good news is that all of this turmoil may eventually lead to a US political party that is socially liberal and economically liberal.  I fear, however, that in the short run we’ll have two economically illiberal parties.


How costly is Chinese IP theft?

Christian List directed me to some studies of the costs of IP theft.  The first link was to an AEI report on the subject, which criticized the US definition of IP theft:

The leaders of the IP commission, Admiral Dennis Blair and General Keith Alexander, penned an opinion piece last year that not only points the finger directly at China but also illustrates confusion as to just what the US should target. They stated: “Chinese companies, with the encouragement of official Chinese policy . . . have been pillaging the intellectual property of American companies.” They listed a large array of US economic sectors as examples, including automobiles, chemicals, aviation, pharmaceuticals, consumer electronics, and software, among others.

But even these two highly knowledgeable leaders then went on to confuse the US case against Beijing’s “pillaging” by adding a list of military IP thefts, including plans and designs related to the F35 fighter, the Patriot missile system, the Aegis Combat System, thermal imaging cameras, and unmanned underwater vehicles, among others, as examples of Chinese spying operations. The problem and confusion to the reader here is that such military espionage is considered fair game by all nations, including the US. And one hopes that US intelligence agencies have been equally diligent in ferreting out Chinese (and other nations’) advanced military designs and equipment.

Chinese theft of US military secrets is certainly something that the US should be concerned about, and try to prevent.  But perhaps the moralistic tone one sees is a bit inappropriate, given that the US government does the same thing.  I’m all for trying to prevent this sort of espionage, but here I’ll focus on commercial theft, which seems to be the bigger issue.  The AEI piece linked to a 2017 US government report on IP theft.  Indeed the term ‘theft’ is used right in the subtitle of the report:


I was thus surprised to see the report discuss activities that cannot possibly be regarded as “theft”:

China continues to obtain American IP from U.S. companies operating inside China, from entities elsewhere in the world, and of course from the United States directly through conventional as well as cyber means. These include coercive activities by the state designed to force outright IP transfer or give Chinese entities a better position from which to acquire or steal American IP.

I.e., we’ll let you invest in China if you share technology.  In fairness, most of the report does focus on three types of outright IP theft:

We estimate that the annual cost to the U.S. economy continues to exceed $225 billion in counterfeit goods, pirated software, and theft of trade secrets and could be as high as $600 billion.

Wait until you see where they got these numbers:

Counterfeit and pirated tangible goods.

In 2016, the OECD and EUIPO used worldwide seizure statistics from 2013 to calculate that up to 2.5%, or $461 billion, of world trade was in counterfeit or pirated products.23 By applying this percentage to U.S. trade, we estimate that in 2015 the value of these goods entering the U.S. market was at least $58 billion.

The United States, however, is a much larger market for imports than the average market. It is nearly equivalent in size to the European Union, where the OECD/EUIPO study determined that approximately 5% of imports are counterfeit or pirated tangible goods. By using 5% as a proxy for the proportion of counterfeit and pirated tangible goods in U.S. imports ($2.273 trillion),25 we estimate that the United States may have imported up to $118 billion of these goods in 2015. Thus, anywhere from $58 billion to $118 billion of counterfeit and pirated tangible goods may have entered the United States in 2015. This represents the approximate value of counterfeit and pirated tangible goods (not services) entering the country.

With respect to counterfeit and pirated tangible U.S. goods sold in foreign markets, the OECD/EUIPO study found that they accounted for nearly 20% of the value of reported worldwide seizures. In 2015, estimated worldwide seizures of counterfeit goods totaled $425 billion, meaning that as much as $85 billion of counterfeit U.S. goods (20% of worldwide seizures) entered the world market (including the U.S. market).

Certainly, in the absence of counterfeit goods some sales would never take place, and thus the value of illegal sales is not the same as the sales lost to U.S. firms. The true cost to law-abiding U.S. firms in sales displaced due to counterfeiting and pirating of tangible goods is unknowable, but it is almost certain to be a significant proportion of total counterfeit sales. For purposes of aggregating the total cost to the U.S. economy of IP theft, we have estimated that 20% of counterfeits might have displaced actual sales of goods. When applied to the low-end estimate ($143 billion) of the total value of counterfeit and pirated tangible goods imported into the United States and counterfeit and pirated tangible U.S. goods sold abroad, the conservative estimate of the cost to the U.S. economy is $29 billion. When applied to the high-end estimate ($203 billion), the cost to the U.S. economy is estimated at $41 billion.

“Displaced”?  So let me get this right. If my wife buys a Coach handbag for $100, and it’s a counterfeit from China, and she enjoys the handbag, then the “cost” to America is $100?  I’m guessing that no actual economists participated in the writing of this government report.

Update:  Bob Murphy pointed out that my wording was wrong.  I should have said; “So let me get this right. If my wife buys a Coach handbag for $100, and it’s a counterfeit from China that displaces the sale of an American handbag, and she enjoys the handbag, then the “cost” to America is $100?”

Otherwise, my point is the same.

You might argue that my handbag example trivializes the problem, and that the real problem is patent infringement, which slows innovation.  I agree.  But how big a problem is patent infringement?  Again, the US government:

The same OECD/EUIPO study found that while 95% of counterfeit goods seized by customs officials were protected by trademarks, only 2% were counterfeits of patent-protected goods.

Here is the summary data for all three types of IP theft:

Totaling It All Up

In summary, we estimate that the total low-end value of the annual cost of IP theft in three major categories exceeds $225 billion, or 1.25% of the U.S. economy, and may be as high as $600 billion, based on the following components:

• The estimated low-end value of counterfeit and pirated tangible goods imported and exported, based on a conservative estimate that 20% of the cost of these goods detracts from legitimate sales, is $29 billion. The high-end estimate for counterfeit and pirated tangible goods imported and exported is $41 billion.

• The estimated value of pirated U.S. software is $18 billion.

• The estimated low-end cost of trade secret theft to U.S. firms is $180 billion, or 1% of U.S. GDP. The high-end estimate is $540 billion, amounting to 3% of GDP.

The software estimates are flawed in much the same way as the pirated goods estimates.  But it really doesn’t matter, because the total estimated cost of IP theft is almost entirely driven by the third category (trade secret theft), especially when you consider that the first two categories use methods that exaggerate the costs by at least an order of magnitude—indeed it’s not obvious that there are any net costs at all.  So where does the trade secret data come from?  The report doesn’t provide any methodology, merely citing a PriceWaterhouseCoopers study.  The following graph summarizes the methods employed by PWC:

Screen Shot 2018-12-08 at 2.20.54 PMPWC have done the following.  They start with the admission that they have no idea how to directly estimate the losses from trade secret theft.  Instead, they look at 8 other types of (mostly) illegal activities, which are also extremely difficult to measure.  Then they notice that 4 of these 8 activities involve between 1% and 3% of GDP.

Where to begin?

1.  Why assume that the estimates for other activities are accurate?

2. Why assume that the loss from trade secret theft is typical of other activities?

3.  If this is indeed the right method, then why not include other illegal sectors, such as the smuggling of tropical birds into the US?  Why just pick the large activities?

4.  Why assume that the size of an illegal activity like drug smuggling is a proxy for the cost of that activity to society?

5.  Why include R&D, which is 2.7% of GDP?  It’s not an illegal activity.  And does it seem plausible that the losses from trade secret theft exceed the total amount spent on R&D? But the high end of their range is 3% of GDP. As an analogy, is it plausible that losses from shoplifting exceed total revenue for retail sales?

6.  Notice that the most similar activity (software piracy) has a far smaller cost than the other 7.

The bottom line is that there is no there there.  No matter where you look, there is no reliable estimate of the cost of IP theft to the US (much less the cost in foregone utility to the entire world.)

In fairness, it’s quite plausible that the losses in this area are pretty large in dollar terms, certainly in the billions, or even tens of billions.  But that view is not based on any of these near worthless studies; rather it’s my intuition given two facts:

1. Information is a more and more central part of the global economy.  Commodities are an increasingly small share of the economy.

2. Information is easy to steal, and can be almost costlessly replicated.

Given these facts, IP theft will almost inevitably be an increasing problem.  Not just with China, but with India and many other countries as well. (Recall the slogan, “information wants to be free”) For fans of IP protection, this theft is a valid concern.

But this perspective also suggests that as with drug smuggling, the problem will be almost impossible to stop.  Consider the 2017 US government report’s discussion of China’s new communication satellite technology:

Perhaps the most recent case is China’s development of the Micius satellite, considered the world’s first quantum communications satellite, which China launched into orbit in 2016. Scientists at national laboratories and academic institutions around the world have been working on developing technology based on quantum mechanics to create a communications system that is considered to be completely secure from penetration. China is eager to develop this technology to protect its own communications from potential adversaries like the United States. However, perhaps ironically, China was able to develop quantum communications technology ahead of its rivals by incorporating their research findings. In an interview with the Wall Street Journal, Pan Jianwei, the physicist leading the project, was quoted saying, “We’ve taken all the good technology from labs around the world, absorbed it and brought it back.” This may be just an innocent quip about how scientists share their basic research findings with one another across borders. However, it has been demonstrated that the Chinese government systematically collects information and secrets from abroad to further its technology development goals, as illustrated by the cases discussed above.

This anecdote reveals more than the US government might have intended.  It suggests that it will be almost impossible to prevent scientific and technical information from rapidly spreading around the world.  The US should still crack down on IP thieves on a case-by-case basis, when they are caught, but we should not assume that this “war” is any more winnable than the drug war. Our pharma companies have basically accepted the fact that they are innovating for the high price American market, and the Europeans and Canadians will (legally) free ride.  Our other companies need to accept that there will be a lot of (illegal) free riding in IP intensive products, and there’s only so much we can do about it when it occurs in other countries.  Starting a trade war is a particularly inappropriate response.

I’m going to end with a comment left by Dallas Weaver after an earlier post on this topic:

You can divide IP into “real deep knowledge based IP” such as detailed scientific inventions and “fluff stuff” like “mickey mouse” or the business methods or “single click” IP.   The latter is obvious and easy to “borrow” and the owner could and do object.  I don’t care that much as the outcome is usually just rent-seeking with little contribution to humanity.

However, in the case of “real IP”, if you don’t have the knowledge base you can’t even steal it.   You could give the detailed IP for the F-35 to all the countries in the world and only a very few could, even, in theory, make the plane.    You can’t steal what you don’t understand.

If you have the ability to steal and utilize “real IP”, you also have the ability to create your own inventions.   Why copy the obsolete designs of others rather than creating improvements.   If you copy, you are always behind the curve.

Modern technology is so complex that the associated IP is all about people who understand the technology and China produces more STEM graduates in two weeks than we do in a year.  Guess who will win the real IP game?   Meanwhile, we demand that the new Ph.D. STEM graduates from our universities who are from China go home after graduation.

Most of the discussions about IP theft are by people who don’t have a strong enough STEM background to really understand what they are talking about.  Even Tyler with his deep understanding of economics doesn’t understand that the “tree of knowledge” is producing more fruit than ever in history, but to reach it requires “standing on the shoulders of giants”.

To even be able to stand on the shoulder of giants requires being able to read primary references in the area and I would like to drop the challenge to the readers to pick up the Reports section of Science Magazine (AAAS Journal) and see how many refereed articles they could read and understand.   When you stand on these shoulders you can see tons of what appears from your lofty perspective “low hanging fruit” for the picking.

PS.  I’m pretty sure that Tyler does understand the amazing fruits produced by the “tree of knowledge”, but I thought his comment made some interesting points.

PPS. I have a related post at Econlog.