Author: Simon Johnson

Letter to Treasury Secretary Janet Yellen: In Support of a Price Cap on Russian Oil Exports

The Honorable Janet L. Yellen

U.S. Department of Treasury

1500 Pennsylvania Ave., NW

Washington, D.C. 20220

October 11, 2022

Dear Secretary Yellen:

We are a group of economists with expertise in oil markets, international trade, and political economy, writing to express our support for the proposed price cap on Russian seaborne oil exports.

As envisaged by the G7, the price cap would set a maximum price that Russian oil could be traded in conjunction with G7 services. This price, set in dollars, would be substantially below the world price, yet above the marginal cost of production in Russia. To use US, UK, EU, and allied financial services (such as insurance, credit, and payments), market participants will need to attest that all qualifying purchases are at or below this threshold.

Given the importance of participating countries for global finance and for shipping, compliance with this cap will create pressure for a lower price on Russian oil moved by tanker. While we do not expect all trades will be performed under the price cap, its existence should materially increase the bargaining power of private and public sector entities that buy Russian oil.

The price cap maintains economic incentives for Russia to produce current volumes. In April 2020, when the price of the Brent benchmark was close to $20, Russia continued to supply oil to world markets, because that price was above the cost of production in many or most existing Russian oil fields. Russian has little or no available onshore storage, and since shutting down and restarting oil fields is expensive and risky, it was more profitable for Russia to continue producing in the presence of low prices. The price of Brent now is around $96 per barrel, but Russia receives significantly less due to the “Urals discount”. This discount is caused by the perceived stigma of buying Russian products for some customers; they decline to bid for Russian oil, which reduces effective demand and lowers the price that the remaining customers need to pay.

The oil price cap proposal would effectively institutionalize the Urals discount and consequently further lower the dollar value of the Russian government’s primary revenue stream.

Under its Sixth Package of Sanctions, the European Union has already adopted a complete ban on using European financial services to transport Russian crude and petroleum products to any destination, along with a complete embargo on EU imports of Russian oil. These measures are due to go into effect on December 5^th.

If the EU implements these measures without a price cap, we would expect the supply of oil to the world market to decline – and benchmark oil prices (e.g., Brent) to rise.

The US and its allies are likely better off with a price cap on Russian oil, and we are encouraged that the EU is making progress on including the price cap in its next round of sanctions. If the world price of oil rises and the cap is effective, Russia will not receive any windfall. And the cap stands a good chance of lowering Russian revenue even if formal participation is limited – by strengthening the negotiating position for anyone willing to buy Russian oil.

According to the IEA, Russian oil exports were 7.6 million barrels per day in August, down only slightly (390 kb/d) from pre-war levels. With revenue from coal and natural gas exports likely to decline and not rebound soon, the Russian government needs substantial oil revenue (in dollars) to pay its bills and keep the ruble from collapsing. The price cap as proposed gives the Russian government the incentive to continue to supply the world market but reduces the revenue available to fund their brutal war in Ukraine.

For these reasons, we support the implementation of the price cap and are hopeful that you and your international colleagues will make progress implementing it soon.

Yours sincerely,

Simon Johnson, Sloan School of Management, MIT

Daniel Berkowitz, Department of Economics, University of Pittsburgh

Severin Borenstein, Haas School of Business, University of California, Berkeley

Steve Cicala, Department of Economics, Tufts University

Kimberly Clausing, UCLA School of Law

Anastassia Fedyk, Haas School of Business, University of California, Berkeley

Jason Furman, Department of Economics and John F. Kennedy School of Government, Harvard University

Luis Garicano, Visiting Professor of Economics, Columbia Business School

Yuriy Gorodnichenko, Department of Economics, University of California, Berkeley

Ryan Kellogg, Harris School of Public Policy, University of Chicago

Christopher Knittel, Sloan School of Management, MIT

Michael Kremer, Department of Economics and Harris School of Public Policy, University of Chicago

Lukasz Rachel, Department of Economics, University College London

Kenneth Rogoff, Department of Economics, Harvard University

Carl Shapiro, Haas School of Business, University of California, Berkeley

Robert S. Pindyck, Sloan School of Management, MIT

Rick Van der Ploeg, Department of Economics, University of Oxford

[Letter updated on October 13, 2022; adding Michael Kremer]

Assessment: Stacey Abrams’ Budget Plan

By Simon Johnson, Ronald A. Kurtz Professor of Entrepreneurship, MIT Sloan School of Management

The plan is based on sound economic and fiscal assumptions and allows for the implementation of policy initiatives without tax increases.

This note provides my assessment of the financial viability of Stacey Abrams’ budget plan for the state of Georgia through fiscal 2028. This assessment was carried out at the request of the Stacey Abrams campaign for Georgia’s governor.

Stacey Abrams’ budget plan is fiscally prudent. The plan is based on sound economic and fiscal assumptions and allows for the implementation of Abrams’ proposed policy initiatives without the need for tax increases.

The most important assumption underlying the budget plan is the projected growth in tax revenues, which in turn depends on the state’s economic outlook. Between fiscal 2023 and fiscal 2028, Abrams expects state tax revenues to grow by 4.6% per annum, in nominal terms. This projection incorporates changes in the state’s tax code resulting from the implementation of House Bill 1437 during the budget horizon. Following its initial implementation in 2024, the tax cuts by House Bill 1437 are triggered only after specified budget benchmarks are achieved, which is not expected until fiscal 2028.

The anticipated growth in tax revenues between fiscal 2023 and fiscal 2028 is consistent with the 4.9% per annum growth in Georgia’s tax revenues over the past quarter century and 7.4% per annum growth over the past decade (see Table 1 below; all figures are in current dollars). This is consistent with reasonable expectations for the continued robust growth of Georgia’s economy. For example, in a recent economic forecast, Dr. Rajeev Dhawan, Director of the Georgia State University Economic Forecasting Center, expects personal income growth of close to 6% per annum through calendar year 2024, and gross state product growth of about the same during the period.

It is important to note that the national and Georgia economies are not expected to suffer a severe recession during the budget horizon, although the economy’s growth is expected to materially weaken through calendar year 2023. However, the impact of the weaker economy on nominal tax revenue growth is mitigated in part by the expected high inflation during the next two years. Inflation is projected to steadily moderate, but it is unlikely to be quickly fall back in line with the Federal Reserve’s inflation target of 2% (measured by the national core consumer expenditure deflator).

Abrams’ policy initiatives would be incorporated into the budget by fiscal 2027. The costliest proposal is to increase salaries for teachers and law enforcement. For teachers, the cost is spread over four years, with the first $2,750 increase in annual pay occurring in fiscal 2024. By fiscal 2027, the entire proposed $11,000 annual salary increase would be in place. The budget cost for these higher salaries increases from just over $400 million in fiscal 2024 to $1.6 billion when fully implemented in fiscal 2027. Law enforcement salaries increase by $6,000 in fiscal 2024 and again in fiscal 2025 at a budget cost of $155 million by fiscal 2025. The cost of Abrams’ proposed expansion of Medicaid coverage is also significant, estimated at $297 million in FY 2024 and growing between $16 million and $18 million yearly after that.

Given the expected tax revenue growth in Abrams’ budget plan and the amount of the state’s current undesignated reserves, the costs of Abrams’ policy initiatives are adequately funded through the budget horizon. In other words, the state will have enough revenue to cover her policy initiatives while also maintaining an adequate reserve with no tax increases.

In addition, there is a substantial cushion provided by currently available reserves. According to the State Accounting Office FY 2022 Report on Revenues and Reserves, the state ended Fiscal Year 2022 with a General Fund balance of $11.82 billion, of which $5.24 billion constitutes the revenue shortfall reserve, which is constitutionally capped at 15% of prior year revenues. This leaves $6.58 billion in undesignated reserves, which are available for appropriation. The Abrams budget plan assumes that the undesignated reserve will fund the gas tax suspension through December 2022 (costing $1.6 billion), that the Abrams proposed tax rebate is implemented ($1 billion), and that the Abrams FY 2024 budget initiatives are funded ($1 billion).

The undesignated reserve will then total roughly $3 billion, allowing for $900 million to fully fund Abram’s budget initiatives in FY 2025 through FY 2027. In FY 2028 the budget will no longer be supplemented with undesignated reserve revenues.

While there is significant uncertainty in any economic and budget projection, the Abrams budget plan for Georgia is appropriately prudent and does not rest on overly optimistic revenue assumptions. The Abrams budget plan strikes a reasonable balance between fiscal prudence and expanding the state’s support for a range of initiatives, without raising taxes.

Table 1: Historical Revenue Growth
FY 1998	$ 11,718,182,319		FY 2011	$ 16,558,647,528	8.8%
FY 1999	$ 12,696,109,796	8.3%	FY 2012	$ 17,269,975,474	4.3%
FY 2000	$ 13,781,937,492	8.6%	FY 2013	$ 18,295,858,589	5.9%
FY 2001	$ 14,688,987,803	6.6%	FY 2014	$ 19,167,806,643	4.8%
FY 2002	$ 14,005,479,208	-4.7%	FY 2015	$ 20,434,743,033	6.6%
FY 2003	$ 13,624,846,657	-2.7%	FY 2016	$ 22,237,392,599	8.8%
FY 2004	$ 14,584,644,741	7.0%	FY 2017	$ 23,268,421,512	4.6%
FY 2005	$ 15,813,996,667	8.4%	FY 2018	$ 24,319,869,276	4.5%
FY 2006	$ 17,338,759,588	9.6%	FY 2019	$ 25,571,064,702	5.1%
FY 2007	$ 18,840,441,639	8.7%	FY 2020	$ 25,478,916,446	-0.4%
FY 2008	$ 18,727,812,623	-0.6%	FY 2021	$ 28,591,830,272	12.2%
FY 2009	$ 16,766,661,804	-10.5%	FY 2022	$ 34,934,855,313	22.2%
FY 2010	$ 15,215,790,786	-9.2%

Imposing Sanctions on Russian Energy Exports

March 3, 2022: By Oleg Ustenko, economic advisor to the president of Ukraine, and Simon Johnson, MIT. Contact: sjohnson@mit.edu. This post is taken from a one page memo, currently circulating.

Sanctions imposed in response to Russia’s invasion of Ukraine are not degrading Russian energy production capacity or putting enough pressure on Russian financial markets.

On the contrary, the price of Brent crude has risen from $80 at the end of 2021 to $90 pre-invasion and reached $113 per barrel today.

The discount on Urals crude relative to Brent has widened since the invasion, but the net price to Russian exporters has still increased by $5-10 per barrel.

IEA reports daily Russian oil export volume is steady at 5 million barrels per day, so oil revenues are up $50-100 million PER DAY since February 24^th.

Russian gas exports to Europe have not been impacted: “the export value of Russian piped gas to the EU alone amounts to USD 400 million per day”.

Total Russian energy exports are generating $1.1 billion per day according to the IEA. This has increased, not decreased, since the invasion began.

The Russian current account surplus in January 2022 was $19 billion, about 50% higher than usual for that month.

The latest sanctions created a positive terms of trade shock for Russia, with a rise in the price of its exports relative to its imports. The only way to put real pressure on Russian public finances is to buy a lot less oil and gas from Russia. Even better: stop all purchases from and payments to Russia.

Recommendations

The US should impose full sanctions, including secondary sanctions, on all Russian oil and gas exports. As a major exporter of refined products made from Russian oil, Belarus also needs to be sanctioned fully.
IEA estimates that oil production around the world can be boosted quickly. Additional world supply can add at least 3 million barrels a day if other producers are persuaded to support the US lead. To the extent Russia can sell on grey markets, this will be at a steep discount. World oil supply will remain about the same, but with significantly less revenue for the Russian government to use in destroying Ukraine and threatening the world.
These measures will encourage the EU to significantly reduce its use of Russian gas, both immediately and through 2022. Energy conservation and development of alternative supplies should also be pursued as a top priority, as suggested by the IEA and Bruegel (two papers). Reducing gas purchases from Russia is essential for global security and any resumption of regional stability.

Jump-Starting America

Can the United States grow faster, create more good jobs, and genuinely spread opportunity?

Yes: by investing more in science and technology, by placing those investments strategically around the country, and by creating an Innovation Dividend – paying cash to all Americans every year, based on the success of public investments in the tech sector.

What technologies should receive support? Which cities have the potential to become the next generation tech hubs? How do we ensure that benefits from the next tech boom are shared more broadly?

Join Jon Gruber and Simon Johnson in discussing their new book, Jump-Starting America: How Breakthrough Science Can Revive Economic Growth and the American Dream, in a series of events and media appearances around the country.

The first public event is on Tuesday, April 9, organized by Harvard Book Store and held at the Brattle Theater in Cambridge, MA: http://www.harvard.com/event/jonathan_gruber_and_simon_johnson/

All are welcome!

What Is the Trans-Pacific Partnership (TPP) Really All About?

By Simon Johnson

The Trans-Pacific Partnership (TPP) is a proposed free trade agreement (FTA) between the United States and 11 other countries. It is comprised of two main parts: reductions in tariffs (and related non-tariff barriers), of the kind typically seen in trade agreements; and new rules for foreign direct investment and intellectual property rights, which have not previously been prominent in FTAs.

The new rules part has become controversial. The case for introducing an investor-state dispute settlement seems less than compelling – this would favor foreign investors over domestic investors, not an idea that sits well with the standard idea of equality before the law (going back at least 800 years) and a direct contradiction to the usual principles of FTAs (emphasizing non-discrimination across types of investors). As currently formulated, it would also be open to considerable abuse. And the precise rules under consideration for patent protection appear likely to reduce access to affordable medicines in both our trading partners and potentially also in the United States.

As a result, advocates of TPP are now emphasizing the benefits of tariff reductions in terms of boosting US exports. But the administration’s claims in this regard are greatly exaggerated and the United States Trade Representative (USTR) is unfortunately refusing to fully discuss the broader trade impact, including the precise impact of higher imports into the United States. Continue reading “What Is the Trans-Pacific Partnership (TPP) Really All About?” →

Why Is The White House Threatening To Veto An Imaginary Trade Promotion Authority (TPA)?

By Simon Johnson

At today’s daily briefing, White House spokesman Josh Earnest communicated the president’s threat to veto any trade promotion authority (TPA) that “could undermine the independence or ability of the Federal Reserve to make monetary policy decisions”. (The question was posed at minute 42:50, Mr. Earnest’s answer starts at 43:31, and the lead up to this quote starts around 45:20.)

Mr. Earnest’s statement seems clear enough, but what potential TPA is he talking about? Either the White House is confused or some other communications strategy is at work here. Either way, Mr. Earnest is describing some imaginary version of TPA that is simply not on the congressional table.

He most certainly cannot be accurately describing the bipartisan Portman-Stabenow amendment, currently before the Senate. This amendment specifically goes out of its way to state that it would not “restrict the exercise of domestic monetary policy.” Continue reading “Why Is The White House Threatening To Veto An Imaginary Trade Promotion Authority (TPA)?” →

The Trans-Pacific Partnership (TPP): This Is Not About Ricardo

By Simon Johnson and Andrei Levchenko

The Obama administration is lobbying hard for Congress to pass a trade promotion authority (TPA) and to quickly approve the Trans-Pacific Partnership (TPP), a free trade agreement that is on the verge of being finalized.

The administration and its supporters on this issue, including leading Republicans, argue that the case for TPP rests on basic economic principles and is only strengthened by the findings of modern research. On both counts their claims are greatly exaggerated – particularly with regard to the notion that more trade, on these terms, is necessarily better for the United States.

There is a strong theoretical and empirical case – dating back to David Ricardo in 1817 – that freer trade should make countries better off. However, modern-day trade agreements, including those currently being negotiated, are very different from earlier experiences with trade liberalization. Continue reading “The Trans-Pacific Partnership (TPP): This Is Not About Ricardo” →

Preventing Currency Manipulation

By Simon Johnson

As Congress debates the trade promotion authority, TPA, the issue of currency manipulation remains firmly on the table. The administration and Republican leadership insist that language discouraging currency manipulation should not be included in the TPA (and also not in the Trans-Pacific Partnership, TPP, a trade agreement currently under negotiation). Many Democrats and Republicans continue to argue in favor of prohibiting currency manipulation.

On Tuesday, the Treasury Department and White House claimed that the amendment proposed by Senators Rob Portman (R., Ohio) and Deborah Stabenow (D., Michigan) would actually impede the ability of the Federal Reserve to conduct monetary policy. This is absurd. The Portman-Stabenow amendment clearly and precisely addresses protracted one-way intervention in foreign exchange markets, i.e., large-scale purchases of foreign assets by a central bank. The Federal Reserve does not engage in such activities – nor will it engage in this kind of intervention in the foreseeable future. US monetary policy involves buying and selling domestic assets. The Fed does not buy foreign assets on any significant scale. There is nothing in this amendment that would impede the workings of US monetary policy. To suggest otherwise is to mischaracterize the nature of this amendment.

There are instead three main issues of substance worth further consideration. Continue reading “Preventing Currency Manipulation” →

No More Cheating: Restoring the Rule of Law in Financial Markets

By Simon Johnson

The political debate about finance in the US is often cast as markets versus regulation, as if “more regulation” means the efficiency of private sector decisions will necessarily be impeded or distorted. But this is the wrong way to think about the real policy choices that – like it or not – are now being made. The question is actually what kind of markets do you want: fair and well-functioning, with widely shared benefits; or deceptive, dangerous, and favoring just a relatively few powerful people?

In a speech on Wednesday, Senator Elizabeth Warren (D., MA) laid out a vision for better financial markets. This is not a left-wing or pro-big government agenda. Senator Warren’s proposals are, first and foremost, pro-market. She wants – and we should all want – financial firms and markets that work for customers, that encourage innovation, and that do not build up massive risks which can threaten the financial system and bring down the economy. Continue reading “No More Cheating: Restoring the Rule of Law in Financial Markets” →

What Is Citigroup Hiding From Its Shareholders Now?

By Simon Johnson

In the early and mid-2000s, Citigroup had compensation practices that can fairly be described as a disaster for shareholders (and for the broader economy). Top executives, such as then-CEO Chuck Prince, received big bonuses and generous stock options. Lower level managers and traders were paid along similar lines. These incentives encouraged Citi employees to take risks and boost profits. Unfortunately for shareholders, the profits proved largely illusory – when the dangers around housing and derivatives materialized fully, the consequences almost destroyed the firm.

The market value of Citigroup’s stock dropped from $277 billion in late 2006 to under $6 billion in early 2009. The shareholders could easily have been wiped out – they were saved from oblivion by a generous series of bailouts provided by the federal government (see Figure 7 in the final report of the Congressional Oversight Panel; direct TARP assistance was $50 billion but “total federal exposure” was close to $500 billion). In the next credit cycle, the experience for Citi shareholders could be even worse. So it is entirely reasonable for shareholders to look carefully at, among other things, the details of how executives and other key employees are paid – and to understand the current incentives for taking and managing risk.

But Citigroup is resisting efforts to disclose fully the structure of relevant compensation contracts. What is Citigroup hiding now? Continue reading “What Is Citigroup Hiding From Its Shareholders Now?” →

Nominate A Qualified Undersecretary Of Domestic Finance Now

By Simon Johnson

The Obama administration urgently needs to nominate a qualified individual as Undersecretary for Domestic Finance at the Treasury Department. The Dodd-Frank financial reforms are under sustained and determined attack, and the lack of a confirmed Undersecretary is making it significantly harder for Treasury to effectively defend this important legislation. Failing to fill this Undersecretary position would constitute a serious mistake that jeopardizes a signature achievement of this presidency.

In the continuing absence of an Undersecretary for Domestic Finance, the administration has recently displayed an inconsistent – or perhaps even incoherent – policy stance on financial sector issues. On the one hand, in mid-December, the White House agreed to rollback a significant part of Dodd-Frank – the so-called “swaps push-out,” which was shamefully attached at the behest of Citigroup to a must-pass government spending bill. The White House put up little resistance to this tactic and, at the critical moment, lobbied House Democrats to support the repeal of Section 716. Continue reading “Nominate A Qualified Undersecretary Of Domestic Finance Now” →

Vote in the Democratic Shadow Primary Now: Support Elizabeth Warren

By Simon Johnson

The shadow primary for the Democratic Party is in full swing. What will be the ideas, themes, and messages that win support in 2016 – and will they carry the day in the presidential election?

You can vote now at the Big Ideas project on almost every viable proposal from the progressive wing of the Democratic Party. Expressions of interest will feed into conversations on Capitol Hill and with presidential candidates. Nearly 1 million votes have already been cast.

Voting ends Friday at noon. Currently, in the section on the Economy & Jobs, the proposal to restore Glass-Steagall is in third place; breaking up Citigroup is close behind. (Vote now for these or for your own priorities.) Continue reading “Vote in the Democratic Shadow Primary Now: Support Elizabeth Warren” →

The Republican Strategy To Repeal Dodd-Frank

By Simon Johnson

On January 7, 2015, Day 2 of the new Congress, the House Republicans put their cards on the table with regard to the 2010 Dodd-Frank financial reforms. The Republicans will chip away along all possible dimensions, using a combination of legislation and pressure on regulators – with the ultimate goal of relaxing the restrictions that have been placed on the activities of very large banks (such as Citigroup and JP Morgan Chase).

The initial target is the Volcker Rule, which limits the ability of megabanks to place very large proprietary bets – and their ability to incur massive losses, with big negative consequences for the rest of us. But we should expect the House Republican strategy to be applied more broadly, including all kinds of measures that will reduce capital requirements (i.e., make it easier for the largest banks to fund themselves with relatively more debt and less equity, taking more risk while remaining Too Big To Fail and thus benefiting from larger implicit government subsidies.)

The repeal of Dodd-Frank will not come in one fell swoop. Rather House Republicans are moving in several stages to reduce the scope of the Volcker Rule and to gut its effectiveness.

The first step in this direction came on Wednesday, with a bill brought to the floor of the House supposedly to “make technical corrections” to Dodd-Frank. This legislation was not considered in the House Financial Services Committee, and was rushed to the House floor without allowing the usual debate or potential for amendments (formally, there was a “suspension” of House rules). Continue reading “The Republican Strategy To Repeal Dodd-Frank” →

Citigroup Will Be Broken Up

By Simon Johnson

Citigroup is a very large bank that has amassed a huge amount of political power. Its current and former executives consistently push laws and regulations in the direction of allowing Citi and other megabanks to take on more risk, particularly in the form of complex highly leveraged bets. Taking these risks allows the executives and traders to get a lot of upside compensation in the form of bonuses when things go well – while the downside losses, when they materialize, become the taxpayer’s problem.

Citigroup is also, collectively, stupid on a grand scale. The supposedly smart people at the helm of Citi in the mid-2000s ran them hard around – and to the edge of bankruptcy. A series of unprecedented massive government bailouts was required in 2000-09 – and still the collateral damage to the economy has proved enormous. Give enough clever people the wrong incentives and they will destroy anything.

Now the supposedly brilliant people who run Citigroup have, in the space of a single working week, made a series of serious political blunders with long-lasting implications. Their greed has manifestly proved Elizabeth Warren exactly right about the excessive clout of Wall Street, their arrogance has greatly strengthened a growing left-center-right coalition concerned about the power of the megabanks, and their public exercise of raw power has helped this coalition understand what it needs focus on doing – break up Citigroup. Continue reading “Citigroup Will Be Broken Up” →

Don’t Repeal Swaps Push-Out Requirements (Section 716 of Dodd-Frank)

By Simon Johnson

Section 716 of the Dodd-Frank financial reform act requires that some derivative transactions be “pushed-out” from those part of banks that have deposit insurance (run by the Federal Deposit Insurance Corporation) and other forms of backstop (provided by the Federal Reserve). This is a sensible provision that, if properly implemented, would help keep our financial system safer, protect taxpayers and reduce the likely need for bailouts.

Now, at the behest of the biggest Too Big To Fail banks and as part of the House’s spending bill (to be voted on tomorrow or in coming days), this “push out” requirement is on the verge of being repealed. Democrats and Republicans should refuse to vote for the spending bill as long as it contains this requirement.

This is not a left vs. right issue. It is a fundamental systemic risk issue, on which people across the political spectrum who want to lower those risks can agree – Section 716 should not be repealed. In fact, some of the sharpest voices on this issue come from the right. Continue reading “Don’t Repeal Swaps Push-Out Requirements (Section 716 of Dodd-Frank)” →