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Why Hoarding Isn’t Always a Bad Thing for GDP

The Buzz

Hoarders beware; the latest GDP print will put you to shame. According the Bureau of Economic Analysis, in the second quarter the US increased inventories at an annual rate of nearly $93 billion dollars. For some perspective, the US economy grew at a 4 percent annualized rate, but the inventory build-up in—called “change in private inventories” or “CIPI”—alone contributed 1.66 percent. More than 40 percent of the growth in the economy was attributable to CIPI.  And that is not great news. Inventories build when the economy produces stuff it does not sell. Granted, there were some bright spots in the report—exports rose and the consumer began to spend again—but not nearly the magnitude that implied by the headline GDP growth rate. Granted, isolating the second quarter as an outlier may well be unfair. After all, the first quarter of this year witnessed inventory destocking drag it down 1.16 percent of its 2.1 percent decline. But the 4 percent growth rate was indisputably deceiving on the surface.

Distortions happen somewhat frequently. In the aftermath of the Great Recession, economic growth in the fourth quarter of 2009 was entirely due to inventory growth. CIPI contributed 4.4 percent and GDP increased only 3.9 percent. Other than increasing inventories, the economy shrank. It works in reverse as well. In the fourth quarter of 2012, the economy only grew 0.1 percent, but CIPI stripped 1.80 percent from the headline. The fundamentals of the economy was performing fine—growing nearly 2 percent, but inventories distorted away the growth.

It is obvious CIPI poses a problem to understanding what is going on in the underlying economy.—even the BEA admits it is incredibly volatile. This makes CIPI difficult to predict, and can contribute to false signals on the economy, like those mentioned above. A similar situation to the Consumer Price index (CPI), where economists look at the “core” which excludes the unstable changes in food and energy, to understand its underlying movements. To get a better look at the underlying economy, the BEA does the natural thing: drop CIPI from GDP.

The “Real Final Sales of Domestic Product”, or Final Sales, figure strips out the effect of CIPI on GDP. In many ways, this resembles more of a “core” GDP than the headline number. The number moves around in much the same way as GDP, but tends to be less wild in its movements. For example, Final Sales is estimated to be -1 percent in the first quarter and 2.3 percent for the second quarter. While not necessarily a more accurate gauge of economic activity, Final Sales provides more clarity into what the economy is actually doing.

The ease with which most economic data can be misunderstood is astounding. But it is not be too difficult to more clearly understand the health of the economy. A less volatile measure of the growth of the economy is desperately needed, and US data watchers and policymakers should place more weight on a “Core” GDP.

Image: Flickr. 

TopicsEconomics

Making Sanctions Against Russia Work

Paul Pillar

Deputy National Security Adviser Tony Blinken was admirably clear and focused in speaking to reporters about the intentions behind the newest round of sanctions against Russia. The purpose, said Blinken, “is not to punish Russia but to make clear that it must cease its support for the separatists and stop destabilizing Ukraine.” We should hope that everything communicated about the sanctions, including what is discussed with Russian officials in private, exhibits comparable clarity and focus.

We can't be sure about that. President Obama's announcement of the new sanctions began with a discussion of the downing of the Malaysian airliner. He referred to buildups of troops on the Russian side of the Russian-Ukrainian side of the border. He talked about how sanctions already imposed have “made a weak Russian economy even weaker.” The reporters present did not help to restore focus. The only two questions the president took were about whether there is a new Cold War and whether he is considering lethal aid for Ukraine.

General discourse about sanctions, whether against Russia or against Iran or some other country, too often treats them as if they really were about punishment. The weakening of someone else's economy gets discussed as if such weakening were itself a plus for U.S. interests, which it is not. The weakening is only a means to some other end, involving a change in the target country's behavior.

Sometimes one might inflict punishment for a past deed in the hope of deterring similar deeds in the future, by either the same perpetrator or someone else. If that is being done, however, the punishment is a one-off action with a definite ending that does not depend on any changes in the other country's behavior. That is not the case with these latest sanctions. Moreover, the downing of the airliner is a poor focus for that kind of punishment because of the accidental nature of the incident. The tragedy of the airliner helps to demonstrate the danger of giving lethal toys to rebels, and politically it clearly had a significant role in moving the Europeans to take stronger action against Russia, but logically and strategically the sanctions should not be thought of as a response to that incident.

Sanctions are a means of affecting the target state's cost-benefit calculus, to increase the chance that state will stop doing something we don't want it to do or to start doing something we want it to do. The first step in a successful application of sanctions is to decide what that something is. This step is more complicated than it might seem, especially with an adversary with whom we have an assortment of grievances. The change in behavior has to be important enough to us to be worth the expenditure of political capital and other costs involved in applying sanctions, but also to be a reasonable enough demand that there is a decent chance the target state will comply. The broader are our demands, the better compliance would be for our interests but the less likely compliance—any compliance—will be achieved.

Blinken's formula that Russia must “cease its support for the separatists and stop destabilizing Ukraine” is a worthwhile and reasonable demand to attach to these sanctions. The stability of Ukraine is certainly important, and Russia's dealings with the separatists appear to have a great deal to do with its current instability. As a matter of international law as well as policy importance, the demand is on sound ground. By the same token, it muddies the water and reduces the chance of compliance to talk about Russia's military deployments on its own side of the border. Those deployments might make us or the Ukrainians nervous, but they are not destabilizing Ukraine. They are taking place on Russia's sovereign territory, there is no demilitarized zone that they violate, and Vladimir Putin would be on sound legal ground to disregard any Western demands about them.

Another step is to communicate clearly to the target country exactly what is the offensive behavior that needs to be changed. Specific, observable and measurable pieces of behavior need to be identified. It is necessary to be more specific with the Russians in private than we have been in public as to exactly what “stop destabilizing Ukraine” means.

An equally important step—one far too often overlooked in much discussion of sanctions—is to communicate persuasively to the target country that the demanded change in behavior is a sufficient as well as necessary condition for the sanctions to be lifted. The leadership of the target country needs to be convinced that, after compliance, sanctions will not be continued because of some other grievance or demand. As Andranik Migranyan notes, this is a hazard in the current instance in that Putin might believe that because of Crimea or some other issue (including those military deployments in Russian territory) sanctions will be left in place. If he does believe that, he has no incentive to comply with any demand.

Finally, it is important to remember that the sanctions are only one term in a cost-benefit calculation. They make it harder for the other country to persist in behavior we don't like. Just as important is to try to make it easier for the other side to switch to behavior we do like. One thing this means in the current instance is that Putin should know that if he does comply, he will be allowed to crow unchallenged about how the West backed down from unjustified economic warfare, and that he will not have to admit anything about arming the rebels in Ukraine—but rather just to end the arming quietly.

Another thing it means is that the United States needs to use its influence to address legitimate and reasonable Russian concerns about Ukraine, including that it not join any military alliances and that the rights and local powers of Russian-speakers in Ukraine be respected. Whether sanctions succeed in influencing decisions in Moscow will depend a lot on decisions in Kiev.

Image: White House Flickr.                                              

TopicsRussia Ukraine

The Next Cuban Missile Crisis: The Showdown in Ukraine?

The Buzz

The window of opportunity for multilateral talks to end the violence in the Ukraine is closing fast.  The EU's fears of imposing stronger economic sanctions against Russia has fallen away in response to its outrage over the MH17 tragedy and evidence that Russia continues to supply heavy weapons to Ukrainian separatists.  The US is expected within days to follow with even more crippling sanctions. 

The positions held by all parties to the conflict - Ukraine, the pro-Russian separatists, Russia, EU and the US - are solidifying to a point where opportunities are becoming fewer for starting negotiations to reduce tensions and prevent future miscalculations like the MH17 disaster that could push Russia and Ukraine closer to war.

During the Cold War, the Soviets and the Western Alliance were implacable enemies.  Still, these foes understood the limits of a confrontation in order to avoid miscalculations that could lead to war.  During the 1962 Cuban Missile Crisis, Kennedy and Khrushchev chose flexibility over hardened positions to avoid a military confrontation that could have started World War III, and afterwards installed the hotline between the US White House and the Kremlin to help prevent future crises. 

In 2014, the stakes for the global community on the worsening situation in Ukraine are not as high as they were in the waters off the coast of Cuba in 1962.  But there is little doubt that all parties to the crisis in Ukraine have become vested in the correctness of their national viewpoint and have little room, if any, for compromise.

All sides share some of the blame.  In Russia, President Putin enjoys record high public support for his position on the Ukrainian separatists, annexing Crimea and reclaiming Russia's role as a global power.  Polling data and anecdotal findings shows a majority of Russians across all age groups are sympathetic to this view. 

In the US, a rigorous national policy debate over the crisis in Ukraine and Russia is long overdue.  The Cold War rhetoric and the demonizing of Russia and President Putin in the media and by several members of the U.S. Congress is driving the policy debate toward knee jerk reactions and away from thoughtful deliberations to forge a consistent long-term Russia policy.  Thomas Graham and Jeffrey Mankoff presented compelling arguments in this publication for such a reexamination of policy. 

Europe was brutally awakened by the MH17 tragedy.  Europe's economic dependency on Russia played a role in its disjointed response to the crisis in Ukraine and factored into Russia's cost-benefit analysis on Crimea and Eastern Ukraine.  Europe must act on developing a Russia policy with a long-term view to reduce its economic dependency on Russia, especially for energy.

The outlook from the Ukraine is not promising.  Attempts by the pro-Russian separatists and the Ukrainian government to find common grounds for negotiations have failed.  Calls for multilateral negotiations have floundered due to a lack of trust on both sides.  A dangerous stalemate is emerging. 

Who will blink first?  Russia?  Maybe, but don't count on it.  While capital flight is at record highs, financing and international investors have virtually disappeared in Russia, the price of a barrel of oil remains at over $100.  Russia withstood the deprivations from a revolution, an existential threat from Nazi Germany and the chaos of the post-Soviet era, and is not likely to give in to the consequences of economic sanctions.  The US?  Not if it develops a long-term and consistent Russia strategy and policy framework, as other crises develop in the Middle East and Asia and draw policymaker's attention.  The EU?  Not if it takes steps to reduce its energy dependence on Russia.

In the meantime, it would be helpful for all sides to reflect on the Cuban Missile Crisis.  Kennedy and Khrushchev learned about the importance of being transactional to avoid letting strongly held positions dictate strategic decisions in the heat of a crisis.

Tom Thomson is the Principal of T. Thomson & Associates, LLC, an international strategy advisory firm, which counsels international companies on business and communications strategies in Russia and Eurasia.  He was based in Moscow for over a decade.  

Image: Public Domain. 

TopicsSecurity RegionsUkraine

Three Reasons Iran Won't Give up Its Nuclear Program

The Buzz

From his 2009 inaugural address to the unprecedented Nowruz greeting, Barack Obama made clear early in his tenure that cutting a deal with Iran over its nuclear program was one of his top foreign policy priorities.  Despite the President’s meticulous attention to details from cyber warfare to sanctions relief, the skeptics are right: Iran is not going to give up its nuclear program. Here are a few reasons as to why:

1.  States that (could) have had nuclear weapons programs and gave them up had close ties to the U.S.

Most states with close military and economic ties to the U.S. forego the pursuit of nuclear weapons in the first place.  Their leaders are savvy enough to realize that a nuclear weapons program would jeopardize their ties with America.  Many of the U.S.’ allies benefit from unhindered access to the global economy.  Furthermore, each of these states hides behind America’s nuclear umbrella.  In exchange for free riding on the U.S.’ extended deterrent guarantees, these states agree to forego nuclear weapons programs.

Pursuing a nuclear weapon is certainly a time intensive affair. It would automatically trigger sanctions, isolating them from the American hegemon upon which they depend for domestic prosperity and international security.  States like Japan, South Korea and Taiwan could have pursued the bomb after China crossed the nuclear rubicon but didn’t because it would have endangered their access to world markets and American protection.

Since 1979, America has not guaranteed Iran’s safety from external aggression, nor has Tehran sought access to the global economy. According to Trita Parsi in, A Single Throw of The Dice, for some mullahs a rapprochement with the U.S. could undermine the legitimacy of the regime.

2.  Once a nuclear program is in motion it tends to stay in motion

States pursue nuclear weapons for a variety of reasons: insecurity, prestige, bureaucratic politics, and easy access to sensitive materials.  However, once a nuclear program has been started, absent regime change, it is hard to unwind.   

Nuclear programs are rich sources of budgetary rents.  These rents are narrowly concentrated among a small number of well-connected lobbies. They will often inflate foreign threats and pick fights for no other reason than to keep open their source of pork.  These groups (such as the Pasdaran) will logroll with other narrowly concentrated interests to maintain the status quo at the public’s expense.  The pro-nuclear cartels tend to win because the general public has an organizational disadvantage.

3.  Both sides have commitment problems:

Because of their historical mistrust, both sides fear being exploited by the other. If a deal is struck with Iran, it is going to be difficult to enforce.  Like any other proliferator, Tehran can renege on the deal unilaterally and secretly.  The Iranians have learned the lessons of Osiraq better than anyone. Their program is so ubiquitously dispersed that even the most intrusive inspections cannot uncover every component of their nuclear program. Unlike territorial disputes, where we can use satellites and third-party monitors to see whether one side violates a ceasefire, we cannot see what Iran is doing in every inch of its own territory, behind (or under) every mountain, or inside of every laboratory.

The U.S. and the rest of the P5+1 fear getting the “sucker’s payoff.”  Many hawks in the U.S. and France in particular have warned that Iran will play for time until it regains access to world markets.  It will then restart its economy and its nuclear program. Any malfeasance on the Iranians’ part will be impossible to punish. Companies that benefit from trading with Iran will hinder efforts to reassemble any multilateral coalition to put the sanctions regime back into place.

However, the P5+1 faces a commitment problem of its own.  For a time a popular saying in Iran was, “Better to be North Korea than Iraq.”  Iraq gave up the bomb but its regime was overthrown and the country was occupied; North Korea kept the bomb and thumbs its nose at America.  The Iranian leadership needs to send costly signals demonstrating that they are moderates.  However, such concessions weaken Iran’s bargaining position vis-à-vis their longstanding rivals in the West and in the Middle East- starting with Israel and Saudi Arabia.  These allowances do not tie the hands of the P5+1, Israel or the Gulf states, preventing them from attacking Iran or making additional demands upon it after it has been denuclearized.

While it is better to jaw-jaw than to war-war, Iran is not going to give up its pursuit of nuclear weapons because it has too much to lose.

Dr. Albert B. Wolf is an Israel Institute Fellow with the Leonard Davis Institute for International Relations at The Hebrew University of Jerusalem.  He is currently writing a book examining the effectiveness of coercive diplomacy in curbing nuclear proliferation.

Image: Office of the President, Iran. 

TopicsNuclear Weapons RegionsIran

The MH17 Disaster: Australia's Shallow Foreign Policy On Display

The Buzz

Generous commentators discern a wider strategy in Australia's mission to the MH17 crash site in eastern Ukraine - a heartening sign of the government's willingness to engage, hard-headed, with the world, wherever Australia's interests demand it.

Today, though, the Australian Federal Police's (AFP) Ukraine Operation is looking more and more like the charge of the light brigade: gallant, but not bright.

For the third day running, the AFP has failed to reach the crash site. The Federal Government has said they could wait for up to three weeks on the outskirts of Donetsk, in the middle of a civil war whose deeper geopolitical issues the Government has by its own admission little interest in.

This isn't the AFP's fault. But those who sent them there appear to have been misled about the conditions they would find.

In place of the ceasefire supposedly provided for by last week's Australian-sponsored Security Council Resolution 2166, the crash site is a battleground as the Ukrainian army attempts to drive a wedge between the rebels and the Russian border. (See, for instance, this New York Times report.)

Indeed, the AFP's Ukrainian hosts stand in breach of a cardinal provision of SC/2166, "that all military activities, including by armed groups, be immediately ceased in the immediate area surrounding the crash site to allow for security and safety of the international investigation."

This puts Australian Foreign Minister Julie Bishop, now back in Kiev, and Australia in an awkward situation. Ukrainian president Petro Poroshenko has every right to feel put upon by Australia's SC/2166: though welcome when it comes to the rebels, it's an obvious burden when it curtails the army's ability to suppress a rebellion on national territory. Certainly, it's a concession of sovereign rights it's hard to imagine any Australian government being prepared to make.

To fix the situation but in reality probably making it worse, Bishop wants Ukraine's parliament (which has not yet approved the Dutch-Australian mission) to approve the arming of the policemen Australia has deployed on its territory.

Yet the only thing worse than having unarmed personnel deployed in this particular warzone on the other side of the world is armed ones.

There are two simple reasons.

First, the Netherlands is a NATO country. Second, Australia is an American treaty ally.

Bishop will have to be very confident that both the Kremlin and the rebels will distinguish the inoffensive purposes of armed Australian personnel as clearly as we do.

That can't be taken for granted.

On Tuesday, the rebels accused the OSCE - the Organization for Security Cooperation in Europe, under whose auspices the mission has been arranged - of serving as a vehicle for American interests.

And from Russia's perspective, the whole point of this conflict is to stop the eastward expansion of Western-led organizations, such as NATO and the EU, which it perceives as a cover for spreading America's sphere of influence over the territories of the former Soviet Union.

Just a few months ago, this geopolitical contest was in earnest. With countries from the Baltic to the Black Seas facing the not implausible threat of Russian invasion, Europe was in the grip of its most serious great-power confrontation since the war-scare of 1983.

Such is the setting in which some are cheered to see the faces of Australian security and, possibly, defense personnel.

There's something of the spirit of 1914 in casting the AFP operation in Ukraine as a chance for Australia to prove, mainly to itself, that it matters on the world stage.

The counter view is that, as the Foreign Minister navigates the shoals of Ukrainian politics, Australia appears at sea in a place and conflict it doesn't understand or wish to - and which, its public statements seem to suggest, wouldn't concern it at all but for the tragic deaths of 38 Australian citizens and residents.

The Prime Minister, too, believes it possible to separate the humanitarian disaster of MH17 from the issue of "the geopolitics of Eastern Europe."

But freedom of maneuver in the space that such separation creates isn't an expectation we normally have when it comes to the unintended civilian victims of war - including the 800 or so civilians whom the United Nations has reported killed since mid-April by Ukrainian army shelling.

We know that our options for helping them are limited for a range of practical, political and military reasons.

Rather, it says a lot about the priorities of modern Australian foreign policy that the country should subordinate other relevant considerations to the exigencies of a consular case.

Of course, it's right for Australia to want to look after its own. But we mustn't exaggerate our ability to do so, whenever or wherever, just because, as Australians, we're fundamentally a good and democratic people with a right to a peaceful existence on earth.

International politics makes no such promises.

As Carl von Clausewitz timelessly observed, war, in eastern Ukraine as elsewhere, is the terrible, but not for that reason irrational, face of a political contest. When it comes to the crash site, it's one whose high stakes on the Ukrainian side as on the rebel don't easily permit of a truce - not even for the sake of a (grieving) third party that claims disinterest but can plausibly be presented as closer in sympathy to one side of the conflict than the other.

Rather than resolve, Canberra's lead-from-the-front attitude suggests a dangerous lack of respect for that political contest itself - and perhaps also for Australia's real strategic interests in it.

Similar complacency last year led the EU into a senseless confrontation with the Kremlin - and a patently high-risk gamble with the hopes and aspirations of the Ukrainian people: as Anatol Lieven, professor of war studies at King's College, London, has pointed out, because of its history, geography and the mixed sympathies of its people, Ukraine could never be asked to choose between Europe and Russia without tearing itself apart.

The West must bear part of the blame for the fact that it has. To the extent that it didn't raise with Brussels or Washington the risks involved, that might even include Australia.

This doesn't absolve the perpetrators of the attack on MH17 of their guilt for that crime. But it does mean that to work out a long-term strategy to guide our actions now, Australia, like other countries, needs to rely less on denouncing Putin and more on hard thinking about the country he leads. As Stephen Walt, professor of international relations at Harvard, has recently written:

Trying to understand what Russia or its separatist allies in Ukraine are doing does not require us to agree with their views or approve of their conduct, especially not now. But unless we make some effort to understand how Russia's leaders see the situation, and what their real motivations are, we are unlikely to formulate an effective policy to address the present crisis.

Those motivations are patently geopolitical and, ultimately, Australia's engagement - intellectual and diplomatic - with the crisis in Ukraine needs to move to that level too.

With the EU agreeing on a tougher regime of sanctions against the Kremlin, Australia probably has little choice but to jump aboard the Western bandwagon. But that doesn't mean Canberra should celebrate a breach in relations with Moscow.

On the contrary, a dispassionate assessment of Australia's long-term strategic interests in Eurasia would suggest that a good relationship with Russia ought to be as important an objective of Australian diplomacy as it ought to be of American diplomacy: the power that stands to gain most from the crisis in Ukraine is neither Russia nor America but China.

The so-called New Cold War between Russia and the West is fast providing the world's "loneliest emerging superpower" with its first great-power ally.

We've long believed that we have, proverbially, "no interests in Europe".

Turns out we do.

In the long run, anger, however righteous, isn't a substitute for doing our homework.

Matthew Dal Santo is a freelance writer and foreign affairs correspondent. He previously worked for the Department of Foreign Affairs and Trade. This article first appeared in ABC’s The Drum here.

Image: Tony Abbott/Flickr.

TopicsMH17 RegionsAustralia

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