North of south, or the economic consequences of Elliott Abrams

Salvaged from the WiP, or why I haven't been posting much...

Okay, here's the set-up. In 1903, the U.S. sponsored the independence of a mercantile breakaway region of Colombia in a strategically very intriguing location. The constitution of this new country permanently linked its new currency, the balboa, one to one with the dollar. In 1914, the Panama Canal was opened. Canal Zone policy did not allow sales to ships on credit. Banks in Panama filled the gap.

Jump-cut bone to space station here. Seventy years after, in a region whose major products were coffee, bananas, and death squads, Panama managed to seize this tiny bit of comparative advantage and leverage it into a national economy centered around financial services. Swiss-style bank accounts, generous corporate tax policies, and a major re-exporting hub, combined with the use of the U.S. dollar and the low inflation caused by the Balassa-Samuelson effect: all these things made Panama an attractive site for many types of business activity.

Small problem: Manuel Noriega. A scary guy, and I'm not talking about the acne. He was the chief of secret police for the charismatic leftist populist Chicago-influenced leader of Panama, General Omar Torrijos, and the guy who (in theory) was going to disable the Panama Canal if the 1977 treaty didn't go through; and after Torrijos's plane mysteriously crashed in 1981, Noriega quickly moved to consolidate power behind the scenes. Money laundering, drug smuggling, dogs and cats living together, mass kleptocracy. One of the cuter scams was that Noriega's associates ran the company responsible for security in the re-export zone. Guess how that worked.

Now, somehow Noriega had got on the bad side of Uncle Sugar. It's rather difficult to pin down the proximate cause, since the fellow had been messing with drugs and money since the 1970s, when he was heavy petting with the CIA, but whatever. Suffice it to say that by the late 1980s, Noriega had turned from "our bastard" to "liability" in the eyes of the Powers That Be. The change might even have been made in good faith.

Manuel Noriega was indicted in a Miami court on February 4, 1988. On March 3, 1988, all the U.S. accounts of the Banco Nacional de Panama were frozen. The Assistant Secretary of State for Inter-American Affairs, Elliott Abrams, gloated to the press about this neat idea, quipping like only an apparatchik can: "Noriega is hanging on by his fingertips. He'll be out of power in a week. Now we'll see who stole the strawberries." But it was a neat idea, if not very well thought through.

Here's the thing: because Panama has no independent currency, it relies on dollar flows from the U.S. to maintain financial liquidity. Panama has no central bank. Balboa notes have only been issued once, in a bizarre episode in the early 1940s, and they were all cancelled. So the mechanism to maintain Panama's financial liquidity was deliberately cut off. When this happens on a widespread scale, it's called a depression. After all, as the history of the twentieth century tells us, nothing causes dictators to lose power more quickly than a depression. The BNP had to close its doors, and other Panamanian banks followed.

It gets better. The BNP, while not a central bank, is the Panamanian clearinghouse for cashing checks. Since Panama had a modern, service-based economy, this made the next payday (March 14) problematic. A general strike quickly ensued. Noriega had an ingenious scheme: pay the workers in commemorative coins! This was nixed by the money mavens on hand.

So, all in all, a lot of calamity, a lot of hardship. Why didn't it work? It took Operation Just 'Cause (originally named Operation Blue Spoon, which I think is much cooler) to oust Noriega. The sanctions did manage to reduce the Panamanian economy by a third, maybe a half, for over a year, precipitating a decade-long jump in unemployment. But that doesn't mean much to a dictator. It's almost the definition: a dictator is a leader who is unresponsive to the popular will.

But a major reason it didn't work was that the Panamanian financial system was remarkably resilient. The Panamanian bankers weren't unsophisticated rubes fresh off the coffee finca. Some of them went to the University of Chicago. They had long practice finding loopholes and workarounds against Uncle Sugar's more anti-Panamanian rulings; they had a decades-long institutional history of doing this.

So the government issued fractional pay checks which could circulate like bills of exchange, increasing the effective money supply. Noriega himself set up Eurodollar accounts using laundered drug money -- sweet of him, and part of the reason he's getting a French vacation -- so that the BNP could finally clear checks and credit card bills. Some banks issued CDs based on savings accounts, which were used for big ticket items. In short, just as the Great Depression sparked a wave of industrial innovation in the U.S., the U.S.-engineered depression sparked a wave of financial innovation in Panama.

The other reason is, private companies sent Panama a lot of dollars so their Panamanian enterprises could stay afloat. Texaco, United Fruit Brands, Eastern Airlines. Not a whole lot in absolute figures, but it helped at the margin. After all, politics is politics, but business is forever.

(PS: Doug, I know the exact word that's tickling the back of your head -- Komarr.)

Comments

[Michael]

Anbody who alludes to Ghostbusters when explaining Latin American economic history is pretty cool in my book.

As a lay observer, I have to admit that I have no idea, really, how economies work. See, in East Central Indiana, where I grew up, it's all very easy to understand. You see the farmers, and you see the auto industry, and that just basically encapsulates everything.

Then I moved to Bloomington. Monroe County has a population of 100,000 people and as far as I can tell, besides moribund, half-hearted excuses for manufacturing facilities, the only employer of any note is the university. They can't all work there, so I don't understand why they're in Monroe County to start with.

And then I moved to Puerto Rico, and I really don't understand why everybody doesn't just starve here. Where does the money come from to fly all this produce in from Florida? It's a complete mystery to me.

My conclusion is that there is clearly more on heaven and Earth than is dreamt of in my philosophy, but as a conclusion, that leaves something to be desired.

[Noel Maurer]

I think I can answer your Puerto Rican question.

In 2005, Puerto Rico imported $46 bn worth of merchandise. How did it pay for that?

Well, it exported $60 bn: $37.1bn of chemicals (mostly pharmaceuticals) $7.1 bn of computer products, $3.6 bn of processed foods, $1.2 bn of electrical machinery, and $11 bn of other stuff.

Puerto Rico sold $60 bn and purchased $46 bn, for a net cash flow of $14 bn.

Problem solved!

Except ... Puerto Rico earned more than $60 bn. Tourists spent $3.2 bn, the federal government spent $1.2 bn in salaries and expenses, Puerto Rican firms sold $1.9 bn of other services to foreigners (e.g., some guy in Florida hired a Puerto Rican lawyer), and Puerto Ricans earned $2 bn on their overseas investments --- which would include, say, the earnings on any investments that you own in the United States, down to a Bloomington checking account.

Puerto Rico also received about $9.3 bn in various transfers, mostly Social Security payments from the federal government.

In other words, Puerto Rico earned about $78 bn, much more than it imported.

Problem more solved!

Actually, it gets a little more complicated, because businesses on the island (mostly those same pharmaceutical and chemical companies doing the exporting) sent overseas about $32 bn in profits and interest payments, and Puerto Ricans bought $5.2 bn in services from elsewhere.

That means that in broader terms, Puerto Ricans earned $78 bn and spent about $83 bn. The gap was plugged by foreign borrowing, half long-term (FDI and the like) and half short-term (Americans depositing money earned in the States into bank accounts in Puerto Rico, or purchasing Puerto Rican securities). That's a big gap, almost 9% of GDP, but it's about what you'd expect from a small poor country locked into a common market and currency union with a big rich one. (For the Canadians reading this blog, replace Puerto Rico with Newfoundland and you've got it.)

Now you now know how Puerto Rico pays for its imports.

But how do people in Ponce afford imported goods? They're not making pharmaceuticals, or working in banks and law firms that sell to American clients, and they don't get all that many overseas tourists. So, how?

Simple. Three channels.

(1) Washington sends some money directly, in the form of social security and WIC.

(2) The people in San Juan or the tourist centers of the east use their export income to get their dry cleaning done, pay rent, eat in restaurants, and fix their cars. Those people then the spend income that they made selling services to the exporters in Ponce. You know, visiting the firehouse or whatever.

(3) The government of Puerto Rico taxes people in and around San Juan and spends the money in Ponce.

So there you have what drives the Puerto Rican economy, and at least a vague idea of how Ponce taps into it.

At least I think you do. If the above didn't make any sense --- I'm writing it in an Austin hotel room while eating a very big steak --- I'd be happy to try again.

[lala]

yes, o, v mysterious. you lost me at strawberries. simple midwestern girl and all.

you know, o, chicago. I asked the Israeli a few years back to really really (!!!) explain to me just one more time (!!) why Saddam Hussein was on trial. and he was like, "honey, I already told you." and I finally was all, yk, blurty and, yk "let's get down" about it, and said, "well! those people! in that village! they tried to kill him? and he was the dictator? duh. so, what is the problem?" and so this just went around & around with unabating confusion on both sides and he finally after 30 or 40 minutes said, "you know? this, this is the mark of the Daley administration on you." I said, "why did you not say this a half-hour ago? I am starving."

[Dennis Brennan]

Go Maroons!

Other universities attempt pranks like "Let's put a police car on the dome." We pull pranks like "Let's put all this uranium in the squash court," or "Let's help Pinochet tear down the Chilean welfare system," or "Let's inject plutonium into people and see what happens." (At least it wasn't feeding radioactive cornflakes to retarded kids-- that was a Harvard thing.)

[Carlos]

LL, you've never seen The Caine Mutiny? you know I like those old movies every once in a while.

Dennis, I think you could pin down Russian shock therapy on not-Yale too. Of course, Yale produced John C. Calhoun.

Claudia recommended a book on the history of vaccine research to me -- it's linked on her blog -- which has stories that make the radioactive cereal study look semi-normal.

[lala]

why, Carlos! no, I was not at all aware of that, being as how we skipped the audiovisual forms of entertainment available to us when we were together, you see then.

(NY1 does not count, friend)

any old way, the only compelling thing about TCM is José Ferrer, but I could be watching the Stooges is what I think about old teevee, mostly.

p.s. Master of Magnetism is convinced that you have a thieving post carrier. we are all afraid to send you any more packages from our household, though we have two among us. we shall pile them up and hire a courier with accountability. xx

[Michael]

Wow, Noel -- thanks! OK, I could have looked this up, I suppose. So ... pharma really does bring that much money onto the island. Freaky.

In re medical research -- apparently a lot of the clinical trials for The Pill were performed here in PR (sometimes without consent) but after it was approved, the pharmaceutical companies refused to market it here...