Washington, DC – Back in December, I flagged a number of downside risks that could derail US economic performance if not carefully managed. Among the risks highlighted was the potential for unilateral actions on the part of the United States to threaten the multilateral trading system, and by extension, global growth.
Eight months on, the Trump administration has indeed delivered on promises to take a more aggressive and unilateralist approach to international economic policy. “America First” has produced investigations into the national security effects of steel and aluminum imports, and into Chinese practices regarding technology transfer and intellectual property, among others. So far this year, we estimate tariffs have been levied on more than $140 billion in traded goods, with another $32 billion in goods impacted if the next round of tariffs in the US-China trade war is implemented on August 23 as expected.
Financial markets have been remarkably resilient to escalating trade tensions. But that composure is being tested by the US decision—announced via presidential tweet last Friday—to double tariffs on Turkish steel and aluminum. The announcement came roughly a week after the US Treasury’s Office of Foreign Assets Control (OFAC) announced it would designate Turkey’s minister of justice and minister of interior as targets of sanctions for their roles in the detention of a US pastor since October 2016. Together, these actions are the latest demonstration of the administration’s willingness to deploy tools of economic statecraft with limited regard for collateral damage.
What makes Turkey different from earlier examples of economic hardball—for instance, threatening withdrawal from the US-Korea Free Trade Agreement and North American Free Trade Agreement, or the possible imposition of tariffs on European automotive imports—is that unilateral actions are being aggressively applied to an economy already beset by underlying vulnerabilities. The resulting market reaction is precisely the point of the administration’s move: the creation of leverage that will induce Turkey to release the pastor. Of greater geostrategic importance, the United States appears also to be ratcheting up pressure on Turkey to curb its economic ties with Iran, with reports that Washington has encouraged Ankara to buy oil from Saudi Arabia instead of Iran. For sure, the approach puts considerable pressure on Turkey and President Recep Tayyip Erdogan to comply; but it also presents the very real risk of spillovers, placing more than just the Turkish economy at risk.
To be clear, Turkey’s economic vulnerability is homegrown. According to the International Monetary Fund (IMF), Turkey’s economic policies have resulted in “clear signs of overheating,” leading to a large current account deficit and large external financial needs. President Erdogan hasn’t helped his cause, naming his inexperienced son-in-law as treasury and finance minister and undercutting central bank independence. Investors are understandably reluctant to give President Erdogan the benefit of the doubt.
Often, when a country loses investor confidence and experiences capital flight, it will turn to the IMF for assistance. IMF financing is provided in the context of a macroeconomic program to smooth the needed adjustment, restoring investor confidence. Under current conditions, however, it’s difficult to see how a large IMF program would be available to Turkey. For starters, the “exceptional access” program Turkey would likely require given its large financing needs would also call for policies that provide a reasonably strong prospect of success, “including not only the member’s adjustment plans but also its institutional and political capacity to deliver that adjustment.” Such capacity is not currently on display. Nor would Turkey receive support from the United States—in the IMF board or elsewhere—so long as Turkey defies US demands.
Given that the United States and Turkey appear locked in a battle of wills, it’s worth asking how vulnerable other emerging market (EM) economies are to a further deterioration of the situation in Turkey. A recent note by the Institute of International Finance (IIF) points out that EM economies are under pressure from multiple shocks, including rising interest rates in the United States and spillovers from the escalating trade war, and lists a number of large EMs, including South Africa, Indonesia, and Colombia, as “at risk” given the rapid buildup of non-resident portfolio inflows in recent years. Previous US administrations, recognizing the importance of global growth to a healthy US economy, have worked to minimize such shocks; the current administration appears far less concerned with the potential for contagion.
In fact, international economic policy under the Trump administration is deliberately designed to extract maximum leverage on the basis of other countries’ economic vulnerabilities.
Further complicating matters for vulnerable EMs, many Republicans in Congress have made clear their opposition to IMF “bailouts”, most recently in a letter from more than a dozen Senators to US Treasury Secretary Steven Mnuchin opposing IMF programs to “countries who have accepted predatory Chinese infrastructure financing.” Given the scores of countries that have received such financing, the United States should take a constructive approach to IMF programs in the presence of Chinese finance and not oppose IMF engagement under any circumstances.
A recent brief by CSIS Senior Adviser Mark Sobel includes proposals to improve transparency of Chinese lending and calls on China to join the international club of official creditors as conditions for engagement. Such an approach would support stabilization efforts while pushing back against China’s so-called “debt-trap diplomacy,” benefitting those countries receiving Chinese finance as well as US interests (and likely China as well).
Let’s hope the administration understands the limits of its high-risk tactics and is closely monitoring the potential for spillovers. Vulnerable economies may not be the only ones disciplined by financial markets.
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