    [House Hearing, 108 Congress]
    [From the U.S. Government Publishing Office]

                           OPENING TRADE IN FINANCIAL
                            SERVICES--THE CHILE AND
                               SINGAPORE EXAMPLES

    =======================================================================

                                    HEARING

                                   BEFORE THE

                                SUBCOMMITTEE ON
                           DOMESTIC AND INTERNATIONAL
                     MONETARY POLICY, TRADE AND TECHNOLOGY

                                     OF THE

                        COMMITTEE ON FINANCIAL SERVICES

                         U.S. HOUSE OF REPRESENTATIVES

                          ONE HUNDRED EIGHTH CONGRESS

                                 FIRST SESSION

                                   __________

                                 APRIL 1, 2003

                                   __________

           Printed for the use of the Committee on Financial Services

                               Serial No. 108-16

    89-081              U.S. GOVERNMENT PRINTING OFFICE
                                WASHINGTON : 2003
    ____________________________________________________________________________
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    Internet: bookstore.gpr.gov  Phone: toll free (866) 512-1800; (202) 512�091800
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                     HOUSE COMMITTEE ON FINANCIAL SERVICES

                        MICHAEL G. OXLEY, Ohio, Chairman

    JAMES A. LEACH, Iowa                 BARNEY FRANK, Massachusetts
    DOUG BEREUTER, Nebraska              PAUL E. KANJORSKI, Pennsylvania
    RICHARD H. BAKER, Louisiana          MAXINE WATERS, California
    SPENCER BACHUS, Alabama              CAROLYN B. MALONEY, New York
    MICHAEL N. CASTLE, Delaware          LUIS V. GUTIERREZ, Illinois
    PETER T. KING, New York              NYDIA M. VELAZQUEZ, New York
    EDWARD R. ROYCE, California          MELVIN L. WATT, North Carolina
    FRANK D. LUCAS, Oklahoma             GARY L. ACKERMAN, New York
    ROBERT W. NEY, Ohio                  DARLENE HOOLEY, Oregon
    SUE W. KELLY, New York, Vice         JULIA CARSON, Indiana
        Chairman                         BRAD SHERMAN, California
    RON PAUL, Texas                      GREGORY W. MEEKS, New York
    PAUL E. GILLMOR, Ohio                BARBARA LEE, California
    JIM RYUN, Kansas                     JAY INSLEE, Washington
    STEVEN C. LaTOURETTE, Ohio           DENNIS MOORE, Kansas
    DONALD A. MANZULLO, Illinois         CHARLES A. GONZALEZ, Texas
    WALTER B. JONES, Jr., North          MICHAEL E. CAPUANO, Massachusetts
        Carolina                         HAROLD E. FORD, Jr., Tennessee
    DOUG OSE, California                 RUBEN HINOJOSA, Texas
    JUDY BIGGERT, Illinois               KEN LUCAS, Kentucky
    MARK GREEN, Wisconsin                JOSEPH CROWLEY, New York
    PATRICK J. TOOMEY, Pennsylvania      WM. LACY CLAY, Missouri
    CHRISTOPHER SHAYS, Connecticut       STEVE ISRAEL, New York
    JOHN B. SHADEGG, Arizona             MIKE ROSS, Arkansas
    VITO FOSELLA, New York               CAROLYN McCARTHY, New York
    GARY G. MILLER, California           JOE BACA, California
    MELISSA A. HART, Pennsylvania        JIM MATHESON, Utah
    SHELLEY MOORE CAPITO, West Virginia  STEPHEN F. LYNCH, Massachusetts
    PATRICK J. TIBERI, Ohio              BRAD MILLER, North Carolina
    MARK R. KENNEDY, Minnesota           RAHM EMANUEL, Illinois
    TOM FEENEY, Florida                  DAVID SCOTT, Georgia
    JEB HENSARLING, Texas                ARTUR DAVIS, Alabama
    SCOTT GARRETT, New Jersey
    TIM MURPHY, Pennsylvania             BERNARD SANDERS, Vermont
    GINNY BROWN-WAITE, Florida
    J. GRESHAM BARRETT, South Carolina
    KATHERINE HARRIS, Florida
    RICK RENZI, Arizona

                     Robert U. Foster, III, Staff Director

                   Subcommittee on Domestic and International
                     Monetary Policy, Trade and Technology

                       PETER T. KING, New York, Chairman

    JUDY BIGGERT, Illinois, Vice Chair   CAROLYN B. MALONEY, New York
    JAMES A. LEACH, Iowa                 BERNARD SANDERS, Vermont
    MICHAEL N. CASTLE, Delaware          MELVIN L. WATT, North Carolina
    RON PAUL, Texas                      MAXINE WATERS, California
    DONALD A. MANZULLO, Illinois         BARBARA LEE, California
    DOUG OSE, California                 PAUL E. KANJORSKI, Pennsylvania
    JOHN B. SHADEGG, Arizona             BRAD SHERMAN, California
    MARK R. KENNEDY, Minnesota           DARLENE HOOLEY, Oregon
    TOM FEENEY, Florida                  LUIS V. GUTIERREZ, Illinois
    JEB HENSARLING, Texas                NYDIA M. VELAZQUEZ, New York
    TIM MURPHY, Pennsylvania             JOE BACA, California
    J. GRESHAM BARRETT, South Carolina   RAHM EMANUEL, Illinois
    KATHERINE HARRIS, Florida

                                C O N T E N T S

                                  ----------
                                                                       Page
    Hearing held on:
        April 1, 2003................................................     1
    Appendix
        April 1, 2003................................................    47

                                   WITNESSES
                             Tuesday, April 1, 2003

    Bhagwati, Jagdish, Andre Meyer Senior Fellow in International
      Economics, Council on Foreign Relations........................    25
    DeRosa, David, President, DeRosa Research and Trading Inc........    28
    Henry, Peter Blair, Associate Professor of Economics, Stanford
      University Graduate School of Business.........................    29
    Lackritz, Marc E., President, Securities Industry Association....    31
    Mendenhall, James E., Assistant U.S. Trade Representative for
      Services, Intellectual Property, and Investment................     8
    Tarullo, Daniel, Professor of Law, Georgetown University Law
      School.........................................................    33
    Taylor, Hon. John B., Under Secretary, Department of the Treasury
      for International Affairs......................................     6
    Vastin, J. Robert, President, Coalition of Services Industries...    34

                                    APPENDIX

    Prepared statements:
        Oxley, Hon. Michael G........................................    48
        Sanders, Hon. Bernard........................................    49
        Bhagwati, Jagdish............................................    51
        DeRosa, David (with attachments).............................    64
        Henry, Peter Blair...........................................   151
        Lackritz, Marc E.............................................   161
        Mendenhall, James E..........................................   172
        Tarullo, Daniel..............................................   177
        Taylor, Hon. John B..........................................   193
        Vastine, J. Robert...........................................   198

                  Additional Material Submitted for the Record

    Frank, Hon. Barney:
        Center for Global Development, prepared statement............   208
        Columbia Business school, prepared statement.................   210
        Investment Company Institute, prepared statement.............   215

                           OPENING TRADE IN FINANCIAL
                            SERVICES--THE CHILE AND
                               SINGAPORE EXAMPLES

                                  ----------

                             Tuesday, April 1, 2003

                 U.S. House of Representatives,
             Subcommittee on Domestic and International
                  Monetary Policy, Trade and Technology
                               Committee on Financial Services,
                                                       Washington, D.C.
        The subcommittee met, pursuant to call, at 10:01 a.m., in
    Room 2128, Rayburn House Office Building, Hon. Peter T. King
    [chairman of the subcommittee] presiding.
        Present: Representatives King, Biggert, Manzullo, Ose,
    Feeney, Hensarling, Murphy, Barrett, Harris, Maloney, Sanders,
    Sherman, Hooley, Velazquez and Frank (ex-officio).
        Chairman King. [Presiding.] The hearing will come to order.
    I welcome all of you here today.
        Today, the Domestic and International Monetary Policy,
    Trade and Technology Subcommittee meets to discuss the
    financial services-related aspects of the recently announced
    free trade agreements. While the issue of trade is generally
    the ambit of other committees, this subcommittee is
    specifically responsible for international investment policies,
    both as they relate to U.S. investments for trade purposes by
    citizens of the U.S., and investments made by all foreign
    entities in the United States. This also includes trade as it
    relates to the U.S. financial sector as a key service industry.
        Today, the subcommittee examines the recently concluded
    free trade agreements with Chile and Singapore. The United
    States reached agreement with these allies on December 10, 2002
    and January 15, 2003 respectively. Many have suggested these
    agreements will help provide a framework going forward from
    which the United States can negotiate with other countries and
    regions. Specific to financial services, these agreements will
    provide much-needed certainty and transparency to allow U.S.
    investment to operate with confidence in these expanding global
    markets. National treatment, capital controls, transparency of
    financial regulation and efficient administrative review are
    just some of the many complex issues that U.S. negotiators have
    addressed in coming to resolution on these specific FTAs. I
    commend Ambassador Zoellick and his team at USTR and the
    Treasury for the work they have done on behalf of the working
    men and women of this country. As a supporter of U.S. free
    trade, I look forward to working with the administration to
    ensure implementation of these agreements.
        I recognize that with any negotiated agreement that there
    will be some who disagree with its provisions. While we can
    agree to disagree, I hope that if there is discussion on these
    disagreements, it will be based on facts and conclusive
    evidence. Today, we have a strong two-panel group of witnesses
    ranging from administration officials to academia to the
    private sector. I look forward to a lively debate on the merits
    of these trade agreements and would remind members that as the
    Financial Services Committee, we would greatly appreciate that
    the topic of discussion remain focused on financial service
    trade issues.
        I now recognize my New York colleague and ranking member,
    Mrs. Maloney, for opening statements.
        Mrs. Maloney. Thank you, Mr. Chairman, for granting this
    hearing, and thank you especially, Ranking Member Frank, for
    working to include this topic in the subcommittee's agenda. I
    know it is an area that you have great expertise and have done
    a great deal of work.
        As the lone world superpower and with U.S. forces engaged
    militarily around the world, the importance of using U.S.
    economic strength to spread American values gains heightened
    importance. Through promotion of rules-based fair trade
    policies, the U.S. has had an opportunity to lead the
    international community for the benefit of both rich and poor
    countries, while at the same time increasing opportunities for
    U.S. businesses and workers. By and large, the bilateral trade
    agreements between the U.S. and Chile and the U.S. and
    Singapore advance this effort. Both agreements knock down
    restrictions on domestic markets that serve to increase in
    efficiency and punish consumers who often pay the cost of
    protectionist policies. In financial services, these bilateral
    agreements offer U.S. companies exciting new opportunities in
    areas as diverse as excess to ATM networks, to increased
    opportunities to compete in new insurance markets.
        Given the many positives in these agreements, it is
    disappointing that our trade negotiators held out for a
    controversial position on capital controls that seeks special
    protection for U.S. investors. The trade agreements contain
    investor-state dispute settlement procedures that determine how
    U.S. investors can win damages if Chile or Singapore violate
    the free transfer provisions in each agreement. Reports
    indicate that these protections for U.S. investors were
    included at the urging of the Treasury Department, and that
    these negotiations over these provisions were some of the most
    contentious areas in the negotiations. Effectively, these
    provisions allow U.S. investors to seek damages in the event
    that Chile or Singapore take measures to limit capital flight
    in the event of a reoccurrence of an Asian financial crisis-
    like emergency. While Chile and Singapore are unlikely to need
    to impose capital controls, many economists have expressed the
    concern that the administration will insist on these provisions
    as a template in future trade negotiations with less stable
    countries.
        Such a policy could lead to a situation where wealthy U.S.
    bondholders have legal claims against a country that has
    imposed capital controls, while all other investors face losses
    and where the country's own people are suffering through an
    economic collapse. This special status for U.S. investors sends
    the wrong message about promoting free trade and could increase
    anti-American feelings. Critics of this policy have said its
    effects are to protect a special class of capitalist, rather
    than to promote stable capital markets.
        In addition to the fairness argument, many economists
    including some at the IMF increasingly believe that the
    imposition of limited capital controls can be an effective
    means of stemming the flight of hot money. In the short term,
    capital controls can increase stability and reassure investors
    that economies are not prone to sudden collapse. I note that
    the witnesses who will express concern about capital controls
    in their testimony today are otherwise staunch free traders. I
    think this lends credence to the argument that at the very
    least, the effectiveness of capital controls is open to debate
    and the rigidity of the administration's position is a concern
    of many mainstream trade supporters and economists.
        I yield back my time.
        Chairman King. Mrs. Biggert, any opening statements on this
    side? I recognize the ranking member of the full committee, Mr.
    Frank.
        Mr. Frank. Thank you, Mr. Chairman.
        Let me pick up from where the ranking member of the
    subcommittee left off with her excellent statement. What is
    striking to me is the number of leading advocates of increased
    trade who are critical of this inclusion of capital
    restrictions. We will have a very distinguished economist,
    Professor Bhagwati; we will have Mr. Tarullo, who helped in the
    Clinton administration push forward with trade agreements, some
    of which I did not agree with.
        I want now at this point to enter into the record a
    statement, first from Nancy Birdsall, who is president of the
    Center for Global Development, a strong supporter of free
    trade.
        [The following information can be found on page 208 in the
    appendix.]
        Chairman King. Without objection.
        Mr. Frank. I appreciate that.
        Secondly, I want to read excerpts from it. I will include
    statements from Joseph Stiglitz. I must say Professor Stiglitz
    and Professor Bhatwati are two of the acknowledged experts
    internationally in support of sensible liberalized trade and a
    globalization that will take us where we ought to go. It is
    impressive to me that both of them are quite critical of this
    particular inclusion of restrictions on capital controls. I
    will now read Mr. Stiglitz's statement. ``The importance of the
    subject of these hearings cannot be overestimated.''
        Let me say that he was not able to come because of
    scheduling problems.
        ``The provisions of the recent trade agreements with Chile
    and Singapore limiting government interventions in short-term
    capital flows are a major source of concern. Everything should
    be done to eliminate them from the agreements and to make sure
    that such provisions are not inserted into future trade
    agreements. Reducing trade barriers can be of benefit to all
    parties. Problems are encountered, however, when trade
    agreements go beyond trade issues, as in this case, forcing
    countries to undertake measures which should be a matter of
    national sovereignty. Such provisions have earned trade
    agreements a reputation for undermining democracy, and I
    believe that sometimes these accusations are deserved.
        ``It is of salient concern with a particular provision that
    risks imposing considerable harm on the country. Much of the
    instability in global financial markets in recent years,
    especially in the emerging markets, has been related to short-
    term capital flows. Capital rushes into a country and just as
    quickly rushes out, leaving havoc in its wake. The crises in
    East Asia were largely caused by premature capital market
    liberalization. The volatility is particularly hard on the poor
    and serves to create poverty. It is the low-skilled workers who
    bear the brunt of recessions and depressions. Chile, in its
    period of rapid economic growth in the early 1990s, imposed
    restrictions on the in-flow of capital. I believe such
    restrictions played an important role in its growth and
    stability.
        ``By the same token, developing countries in Asia that have
    grown the fastest, done the most to eliminate poverty and
    exhibit the greatest stability, have all intervened actively in
    capital markets at critical stages in their development, and
    many continue to do so today.
        ``Let me be clear, while there were financial interests in
    the United States that might benefit from forcing countries to
    open up to the short-term capital flows, and there are even
    some who have benefited from the resulting economic chaos by
    buying assets at fire-sale prices only to re-sell them at great
    profit when economic calm has been restored, forcing countries
    to open up their markets to these short-term capital flows is
    not in the interests of the United States. It is in our
    interest to have a more stable global economy. It is in the
    interest of businesses that are investing abroad that there be
    greater economic stability.
        ``Yet economic research has identified short-term capital
    market liberalization as the single most important factor
    contributing to the instability in Asia and Latin America.
    Today, there is a growing consensus among economists against
    liberalizing capital markets for short-term capital flows for
    most emerging countries. Even the IMF has recognized this. The
    extent and form of capital market liberalization is a matter
    which should be left for each country to decide through
    democratic processes.
        ``We can encourage a full democratic debate on these issues
    with a public discussion of experts in developed and developing
    countries, debating the advantages and disadvantages. But we
    should not be using our economic power and the promise of
    increased investment and exports to impose the viewpoint of a
    particular set of interests or a particular ideology on our
    trading partners.
        ``The arguments for trade liberalization are totally
    distinct from those for capital market liberalization. They
    share in common but one word--liberalization. There is an
    emerging consensus among economists that emerging markets
    should be particularly wary about full capital account
    liberalization. It makes little sense for our trade agreements
    to be pushing on our trading partners restrictions which fly in
    the face of sound economics.''
        Let me just reiterate, it is clear we in this case imposed
    on both Chile and Singapore over their initial objections and
    their continuing objections this particular addition to free
    trade. I think that it is very important to understand, I would
    hope that we would move toward a consensus on freer trade,
    globalization, taking into account other values. This inclusion
    of a very rigid particular ideological view using America's
    power to impose these in individual free trade agreements goes
    exactly in the opposite direction.
        Chairman King. Thank you, Mr. Frank. I would ask if any
    other members have an opening statements, that they submit them
    in writing so we can get to the statements of our witnesses.
        Mr. Sanders?
        Mr. Sanders. Thank you very much, Mr. Chairman.
        This is an important hearing. It is an important hearing
    because it raises discussion about our trade policy. It is
    important to begin to talk truth about our trade policy and
    recognize that from beginning to end our trade policy has been
    an outrageous failure. And it is incomprehensible to me that
    people keep coming forward--we had Alan Greenspan in front of
    the full committee a couple of months ago talking about the
    ongoing success of our trade policy. I wonder. I scratch my
    head and I say, what world are these people living in?
        If our trade policy is such a success, Mr. Chairman, why do
    we have a $400 billion trade deficit? Why in the last two
    years, and let me reiterate this, because it is not talked
    about too often by all the editorial writers who support free
    trade, how come in the last two years on our ongoing success of
    free trade, we have lost close to two million manufacturing
    jobs--10 percent of our manufacturing workforce? How come 20 or
    30 years ago, General Motors used to be the largest employer in
    America where workers earned a decent wage?
        And Mr. Chairman, you know who the largest employer in
    America today is? It is Wal-Mart, where large numbers of people
    are on food stamps. How come any concrete examination of NAFTA
    will tell us that it has been a disaster for the people of
    Mexico, for the middle class, the poor people of Mexico, as it
    has been a disaster for working people in this country?
        I returned from China a month ago. It is not just that we
    have a $100 billion trade deficit with China. If anybody thinks
    that all the Chinese are going to be doing is stuffing teddy
    bears and making sneakers, you are absolutely mistaken. All of
    the evidence is there. It is not just blue collar jobs that are
    going to be replaced. It is white collar jobs and that is
    taking place right now. All of the evidence is there.
        Mr. Chairman, I have a long statement which I would like to
    submit for the record. But I think that extending our trade
    policy should be laughed out of the Congress. We should be
    saying, are you serious? Obviously, you are joking, aren't you,
    coming here asking us to extend a disastrous trade policy. You
    are not really serious? We all have a good sense of humor. But
    to tell us to extend a disastrous trade policy which is causing
    havoc not only for the middle class, the working class of this
    country, but for poor people all over the world. Tell us about
    what is going on in Latin America--Venezuela, Argentina, the
    huge uprisings, mass demonstrations against the IMF, against
    these trade policies.
        Now, obviously we understand what goes on in American
    politics. Large corporations flood this building with huge
    contributions. Yes, I admit it. Trade policy works well for
    those companies that want to throw American workers out on the
    street and hire poor people for pennies an hour. Yes, I grant
    you. It works well for those CEOs that make a few hundred
    million dollars when they retire. But for the poor people of
    the developing world and for the middle class of this country,
    it is a failure, and the idea that we are thinking of extending
    our trade policies should be laughed out of this office.
        I would ask unanimous consent to allow my statement to be
    submitted for the record.
        Chairman King. The gentleman's time has expired. Without
    objection, his full statement will be made part of the record.
        [The prepared statement of Hon. Bernard Sanders can be
    found on page 49 in the appendix.]
        With that, we will go to our first panel today--the
    Honorable John B. Taylor, Under Secretary of Treasury for
    International Affairs, and Mr. James Mendenhall, Assistant U.S.
    Trade Representative for Services for Investment and
    Intellectual Property. We will begin with Mr. Taylor.

     STATEMENT OF HON. JOHN B. TAYLOR, UNDER SECRETARY OF TREASURY
                       FOR INTERNATIONAL AFFAIRS

        Mr. Taylor. Thank you very much, Mr. Chairman, and Ranking
    Member Maloney for calling this hearing and inviting us to
    testify. I would like my oral remarks to just summarize briefly
    the written testimony and submit the written testimony to the
    record.
        Chairman King. Without objection, your full statement will
    be made part of the record.
        Mr. Taylor. I would like to focus in my oral remarks on
    provisions related to trade in financial services and to
    investment in capital transfers in the free trade agreements
    with Chile and Singapore. Let me focus first on trade in
    financial services.
        We believe that reducing barriers to trade in financial
    services is an essential part of a good trade policy which aims
    to reduce barriers of all kinds to trade. Open financial
    sectors lead to more growth. They lead to a better allocation
    of savings. They lead to better services for people who take
    advantage of the better financial services. There is a
    reduction in the barriers to trade in financial services that
    is part of the two free trade agreements that we are discussing
    today. For example with respect to Singapore, Singapore has
    agreed as a matter of opening its market to financial services,
    to lift the ban it has had on new licenses for banks to operate
    in Singapore. It has also allowed for banks to get access to
    additional ATMs that are run by local banks. And it has reduced
    the limits to the number of ATMs that banks can have. So you
    can just see by these examples that these are the kind of
    things that improve the financial services that are available
    to people in Singapore, and at the same time bring business
    opportunities to U.S. firms.
        With respect to Chile, Chile has agreed that it would make
    prior notice to any regulatory changes that might have bearing
    and implications for financial service firms. It is also
    providing more access to financial advisers and financial
    management firms who want to take a role in the management of
    the Social Security accounts in Chile. These are just some
    examples of the specific things that U.S. firms and consumers
    in Singapore and Chile can benefit from from reducing the
    barriers in financial services. On top of all those, as a
    chapeau, is an agreement that there would be a lock-in, a
    commitment not to remove these commitments, not to increase the
    barriers their current levels, so that there is no going back
    from the position where the countries are with respect to
    financial services.
        Let me now briefly talk about the investment in capital
    transfers part of the agreements. Reducing barriers to the flow
    of foreign investment is also an essential for raising economic
    growth and reducing poverty in countries around the world. More
    capital means there is more capital for workers to use to
    produce, to raise their productivity. Access to capital is an
    essential way to reduce poverty by raising productivity. One of
    our major objectives in this administration is to reduce
    barriers to the flow of capital to emerging markets in
    developing countries in general, and thereby having greater
    productivity and lower interest rates as well. I just might
    mentioned as an aside that the president's proposal for
    Millennium Challenge Accounts, which is aimed at the very
    poorest countries in the world, has as a feature a way that
    their policies will be ones that attract foreign investment and
    attract capital so that again productivity can increase and
    poverty can be reduced.
        Another example of how our policy is aimed to improve
    foreign investment around the world is our long-term BIT
    policies, the bilateral investment treaties, which have been
    underway for the last 20 years. These bilateral investment
    treaties are an effort to make the policies in the countries
    more welcoming to foreign investment so that the countries
    themselves can benefit from it, as well as the foreign
    investors.
        Now, our FTAs with Singapore and with Chile have endeavored
    to stick with this policy of free transfers that exists in our
    bilateral investment treaties. I would say that all sides to
    these agreements with respect to the Chile, the Chileans and
    the Americans, with respect to Singapore, the Singaporeans and
    the Americans--they have agreed that there is an importance to
    have this free transfer of capital. They agree that
    restrictions on transfers would clearly not be consistent with
    the goal of encouraging investment to raise productivity and
    reduce poverty.
        As with the rest of the free trade agreement, there is a
    dispute settlement mechanism that we put in place. It comes
    into play when there is a restriction placed on goods trade,
    service trade, or on capital transfers. The dispute settlement
    mechanism that we negotiated with respect to capital transfers
    we think makes a lot of sense and it is one that both the
    Chileans and the Singaporeans are happy with, as we are. In the
    case of restrictions on capital, there is a cooling off period
    before a dispute settlement mechanism comes into place. For
    foreign direct investment type of investment, the cooling off
    period is for six months before action can be taken. For other
    types of restrictions, the cooling off period is for 12
    months--other types of restrictions on shorter-term capital
    movements--direct loans. So there is a longer cooling off
    period for the types of capital transactions and capital flows,
    capital transfers that several of you have already raised in
    your opening remarks.
        We think this dispute settlement mechanism builds on
    current practice, but allows for a compromise for different
    views about how capital markets work. We think it is a good
    place to have the subject of transfers dealt with in
    agreements. It is a novel approach and we think it works quite
    well.
        Let me just summarize after giving these specifics. We
    think that the approach undertaken in these FTAs is consistent
    with a shared economic philosophy and policy perspective of all
    three countries that we are talking about--the United States,
    Chile and Singapore. The inclusion of these free transfer
    provisions, as I have just described it, in the Chilean and
    Singaporean FTAs with the United States we think sends a strong
    signal to the markets that all these countries support the free
    flow of capital and they recognize its importance to the
    development and growth of economies. Without a doubt, these
    agreements represent a win-win situation for all the countries
    involved.
        I would like to thank you very much, Mr. Chairman, and to
    your colleagues, for the opportunity to testify here and look
    forward to a discussion of these issues.
        Thank you.
        [The prepared statement of Hon. John B. Taylor can be found
    on page 193 in the appendix.]
        Chairman King. Thank you, Secretary Taylor.
        Mr. Mendenhall?

        STATEMENT OF JAMES E. MENDENHALL, ASSISTANT U.S. TRADE
       REPRESENTATIVE FOR SERVICES, INVESTMENT AND INTELLECTUAL
                                PROPERTY

        Mr. Mendenhall. Good morning, Mr. Chairman, Ranking Member
    Maloney and Mr. Frank and other members of the committee. I
    appreciate this opportunity to come before you today to testify
    on the financial services chapters in the Chile and Singapore
    free trade agreements. I particularly look forward to this
    discussion because I am newly appointed in my current position
    as assistant U.S. Trade Representative and this is my first
    opportunity to discuss these issues with you.
        Since the passage of the Trade Act of 2002, we have pursued
    an aggressive trade agenda. As stated by Ambassador Zoellick,
    we are proceeding with trade initiatives globally, regionally
    and with individual nations. This strategy creates a
    competition in liberalization, with the United States at the
    center of a network of initiatives. The recently completed
    agreements with Singapore and Chile represent the first of the
    next generation of trade agreements. We have also launched FTA
    negotiations with five other countries or regions, and at the
    same time the free trade are of the Americas negotiations are
    ongoing and are set for completion by January of 2005. On the
    multilateral front, just yesterday the United States submitted
    its initial offer in the current round of services negotiations
    in the WTO.
        For several reasons, Chile and Singapore provided a good
    point of departure. First, the United States has a growing and
    significant economic interest in trade with these countries.
    Second, specifically with respect to financial services,
    Singapore and Chile have taken steps to open their financial
    sectors. Both countries respect the concept of the rule of law
    and were in a good position to explore market access-enhancing
    concepts relating to transparency of regulatory structures.
    They have already committed to moving in the right direction
    for many sectors and our FTAs will reinforce these trends.
        Finally, the Chile and Singapore FTAs provide good toe-
    holds for expanding liberalization in South America and Asia
    respectively. The liberalization of financial services was one
    of our main objectives in negotiating the Chile and Singapore
    FTAs. In the final texts, we achieved the objective set forth
    in TPA to eliminate discriminatory and other types of
    restrictive measures on the supply of services. The United
    States already enjoys a significant competitive advantage in
    financial services in international markets, and the market-
    opening initiatives in the Chile and Singapore FTA and in other
    for a should create additional opportunities for our financial
    services suppliers. Opening foreign markets for exports of U.S.
    financial services has two added advantages. First, it creates
    jobs and expands economic opportunities. For example, states
    like New York, California, Florida, Illinois, Massachusetts and
    Pennsylvania depend on financial service activity to contribute
    to their economic growth and tax base. Also by expanding access
    to financial services, it enhances prospects for economic
    growth at home and abroad.
        Second, the opening of foreign markets for financial
    services creates export opportunities for other sectors. For
    example, financial services companies rely heavily on
    specialized software and data processing, thereby creating
    increased demand for computer-related services which is another
    strong point of the U.S. export picture. And as countries
    develop their economies with the help of foreign financial
    services, those countries consume a wider range of goods and
    services, which benefits U.S. exporters more generally.
        The financial services chapters in the Chile and Singapore
    FTAs cover all means of supply that are relevant for financial
    services trade, and include a set of important core
    protections. The agreements require national and most-favored-
    nation treatment, which ensures that U.S. financial service
    suppliers are treated on equal terms with their foreign
    competitors. They also include a market access obligation to
    ensure that measures such as quantitative restrictions and
    requirements regarding forms of legal entities do not undermine
    general market access rights. Lack of transparency is also a
    major problem facing our financial service suppliers, and we
    have included provisions that directly address this more
    subtle, but equally insidious market access barrier. In
    addition, we have provided rights for foreign-owned
    institutions to introduce new financial services when certain
    conditions are met.
        Finally, I would like to say a word on the issue of capital
    controls. The issue of capital controls is clearly complex, yet
    we have to recognize the potentially serious negative impact
    capital controls could have on U.S. investors. Our FTAs contain
    safeguards to allow American investors to have access to their
    funds, while at the same time they grant Chile and Singapore
    the flexibility to manage capital flows.
        The Chile and Singapore FTAs mark a significant advance
    over commitments in other fora. For example, unlike in some
    other agreements, our Chile and Singapore FTAs adopt a
    presumption that national treatment will apply unless a
    specific sector is carved out. Chile and Singapore have agreed
    to commitments across a wide array of financial services that
    exceed the level of the current GATT's commitments. In some
    cases, they have undertaken commitments to preserve existing
    levels of openness that go beyond their GATT commitments, while
    in other cases they have agreed to commitments that go beyond
    the current practice. We would be pleased to discuss specific
    commitments with you here today or to meet separately with you
    and your staff to discuss in further detail.
        While we have moved aggressively to open foreign markets,
    we are sensitive to the careful balance struck through our own
    political and legal processes between regulatory and commercial
    interests. In fact, while the United States agreed to a high
    level of access under the Singapore and Chile FTAs,
    implementation of the financial services chapters in the FTAs
    will not require any changes to U.S. law or practice.
        We can expect real benefits to accrue to the U.S. economy
    as a result of the Chile and Singapore agreements. As we
    advance a strong trade promotion agenda, we remain ever-mindful
    of the objectives Congress asked us to achieve when it granted
    trade promotion authority. I look forward to working with you
    and your staffs in the future as we strive to continue opening
    markets around the world. I thank you for the opportunity to
    testify here today.
        [The prepared statement of James E. Mendenhall can be found
    on page 172 in the appendix.]
        Chairman King. Thank you, Mr. Mendenhall.
        As you can determine from some of the opening statements,
    there is a concern, I believe, by certain members of the
    committee and certain members in the Congress that in certain
    elements of the negotiations the United States may have used
    coercion or improper pressure to cause Singapore and Chile to
    agree to, or to make certain concessions they would not have
    made otherwise, specifically in the area of capital controls.
    If you could address that to the extent you can, how the give
    and take went, and why you feel that this is essential as far
    as capital controls.
        Mr. Taylor. I would say the give and take was healthy and
    candid, like any other negotiation that I have been involved
    with. The issues are very complex, as Mr. Mendenhall indicated.
    There are different points of views. But I think what was most
    often emphasized to us is that the free transfers of capital is
    important by Singapore and by Chile. They have those policies
    in place right now. Neither country has capital controls in
    place. We were working with them. In fact, many of the ideas
    that are in this were mutually reached in the discussions. So I
    would say that they were good. They were healthy. Some of them
    took place in Singapore. Some of them took place in the United
    States. They were part of a larger trade agreement, to be sure,
    in which there were many issues being discussed. Financial
    services and some of the others we discussed here, but there is
    trade in goods as well.
        Chairman King. Mr. Mendenhall, do you have anything to add
    to that?
        Mr. Mendenhall. I agree with everything that Under
    Secretary Taylor just said. I think in the give and take of
    these negotiations, it is just that--a give and take. However
    much we may like to lay down the law on a particular point and
    force our trading partners to accept it, it is a negotiation.
    In fact, I believe where we ended up with on capital controls
    was the result of a negotiation. It was not the result of the
    United States imposing its will in any way, although Under
    Secretary Taylor would know this more than I would on that
    particular issue. I believe that was the case here.
        Chairman King. Secretary Taylor, in your testimony you
    discuss the president's MCA initiative. Can you go into more
    detail on that as to how you believe the requirements of the
    MCA will make this country more attractive to investors?
        Mr. Taylor. Mr. Chairman, the Millennium Challenge Account
    is a program which is designed for which funds will go to
    countries that are following policies that are conducive to
    economic growth. Many of those same policies are conducive to
    foreign investment. So for example, there are the three
    categories of policies--ruling justly, investing in people, and
    encouraging economic freedom. In the ruling justly part of the
    policies, there is an emphasis on the rule of law so for
    example, foreign investors know the rules of the game before
    coming into a country. It is a very important part of the
    Millennium Challenge Account--the rule of law. In the
    encouraging economic freedom section, there is a commitment to
    have a low inflation rate, a stable macroeconomic environment,
    which is also conducive to foreign investment. It creates
    greater certainty. In the investing in people part of the
    Millennium Challenge Account, it is a commitment for countries
    to invest in their people, in education and health. So
    obviously, a good well-educated workforce is one of the best
    ways that foreign investment can be productive in a country.
        So just for example, as you know, some foreign investment
    in Africa has taken advantage of countries where the skill
    level is rising. In Ghana for example, education is improving
    and we see U.S. firms and other firms going in to take
    advantage of that for computer work, for call centers. Those
    are the kind of foreign investments that can actually improve
    well-being in the country directly. The Millennium Challenge
    Account encourages that through the policies that I indicated.
        Chairman King. Mr. Mendenhall, do you have anything to add
    to that?
        Mr. Mendenhall. No, I agree.
        Chairman King. Mrs. Maloney?
        Mrs. Maloney. Thank you for your testimony. Secretary
    Taylor and Mr. Mendenhall, in future trade agreements and
    negotiations, what will be the position on capital controls? Is
    the language in the Chile and Singapore agreements an example
    for future negotiations? Is this something we are going to
    continue or is this just for these two very strong economies,
    Chile and Singapore?
        Mr. Taylor. I think the strategy of focusing on dispute
    resolution is one that we have found attractive in dealing with
    these negotiations, and we would like to see how that works
    with respect to other countries.
        Mrs. Maloney. So do you plan to use this in other trade
    agreements? That is what I want to know.
        Mr. Taylor. Yes, I think the dispute resolution mechanism
    is a good way to handle this. It is very attractive to both
    Chile and Singapore, but the specifics will differ by country.
    I gave the example of the six-month and twelve-month--maybe
    those numbers would change. I gave examples of what kind of
    foreign direct investment type of investments at the six-month.
    Maybe that would change. But I would say it would depend on
    what the country wants to do. The country is negotiating with
    us. They have their own interests and their own desires. We
    think this general approach works well, and would like to try
    it out as we go, but it is flexible. It is one of the good
    advantages of it, it is flexible. And it does have this
    constant ability for us to emphasize the importance of foreign
    investment and free transfers and not putting restrictions on
    capital, at least trying to stay away from that as much as
    possible. That is a philosophy that is embedded in the
    approach.
        Mrs. Maloney. Secretary Taylor, your testimony reads, and I
    quote, ``our position is to seek greater protection for U.S.
    investors than the IMF articles of agreement and the GATTs
    afford,'' end quote. If this language is included in trade
    agreements with countries that are more prone to economic
    collapse than Chile and Singapore, are you concerned about the
    international fall-out in a situation where U.S. investors win
    compensation, while all other foreign investors face losses and
    while a suffering country's own people are experiencing an
    economic collapse?
        Mr. Taylor. The comparison with the GATTs is important. The
    way I think about it, an FTA, a free trade agreement, is an
    effort to get a reduction in barriers compared to what you
    would have if you did not have a free trade agreement. It is an
    opportunity for both countries to reduce barriers compared to
    what would exist out there under the GATTs or under other
    multilateral trade agreements. So it is natural that the
    barriers are less in a free trade agreement and that is what
    you are seeing here. With respect to other countries, as we go
    forward, I just go back to my previous answer that it will
    depend on the country's situations and what they really would
    like. We have noted in just going over our BITs and reviewing
    all the BITs we have had, that there are many very poor
    countries who welcome the opportunity to pledge to make it
    clear in an agreement that they were very welcome to foreign
    investment and very open. My best guess is other countries are
    going to do that as we do more BITs and as we do more FTAs, but
    it very much depends on the countries and the negotiations.
        Mrs. Maloney. I want to follow up on if we go into these
    trade agreements and U.S. investors are able to recover for
    losses caused by imposing the capital controls, won't foreign
    investors learn to channel their own investments through U.S.
    investment banks, so that they would get the protection of the
    U.S. trade agreements? It is not going to be long that they are
    going to see if I put my money in, I cannot get it out; if I go
    through the U.S., I will be able to get my money out. Does that
    increase efficiency? What would the impact of that be? If I
    were a foreign investor, I would immediately start going
    through U.S. banks to make sure I could have the same treatment
    that U.S. investors have.
        Mr. Taylor. I think that is an observation which is
    important. I think that if you recognize the dispute settlement
    mechanism that we are using here in the free transfers is
    similar to dispute resolutions that occur in other places. For
    example, it is called investor state, and investor-state gives
    the opportunity for individuals to take action in an agreement
    like this.
        Mrs. Maloney. I was not aware other countries had the same
    language. I thought we were unique in that respect.
        Mr. Taylor. What I was going to say is it occurs in other
    trade agreements. I have not observed any particular phenomenon
    that you are mentioning in our other agreements. In a way what
    we have done in the capital area here is lengthen the cooling
    off period from what it was otherwise, because the six-month
    cooling off period in other agreements I do not know exactly
    the time in the BITs, but there is always a cooling off period
    of some kind; there is always and investor-state dispute
    resolution mechanism in all of our bilateral investment
    treaties, and in NAFTA.
        Mrs. Maloney. But Mr. Secretary, even after a year couldn't
    they face the same problems with the economic collapse of their
    own people, other investors not being able to get their money
    out? Even after a year, you would still have the same elements
    that could be problematic, wouldn't you?
        Mr. Taylor. The year gives it more time to sort things out,
    and it is a substantial period with respect to any of the
    desires or any of the requests that I have ever seen that the
    countries would like to put on controls like this. So that
    leeway seemed very acceptable to both Chile and Singapore, and
    I believe to other countries as well. Remember, neither
    Singapore nor Chile are using these controls right now.
        Mrs. Maloney. My time is up. Thank you for your testimony.
        Chairman King. Mrs. Biggert, the vice-chair of the
    subcommittee.
        Mrs. Biggert. Thank you, Mr. Chairman.
        The Asian financial crisis has been cited here and it is
    often cited by proponents of capital restrictions as a reason
    why developing countries should be able to limit the movement
    of capital within their borders. But wasn't the Asian crisis
    the result of a weak banking system and cronyism and
    ineffectual regulation? With increased trade in financial
    services and greater regulatory transparency, will countries
    that were once vulnerable to currency crises be stronger and be
    able to withstand economic downturns?
        Mr. Taylor. Yes, I agree with that very much. What we have
    seen when investment is open to foreign companies or financial
    services firms, it frequently brings in better prudential
    regulations. With respect to the first part of your question,
    yes I very much agree that a lot of the crisis had to do with
    currency mismatches, where liabilities and assets did not match
    by currency, and that was because of defective regulations in
    many cases. So that can be improved and I think the foreign
    investment and the experience of financial service firms in the
    United States and other developed economies can be very
    helpful.
        Mrs. Biggert. And then going back to the short-term
    restriction on the transfer of capital which was put in for
    Chile and Singapore, can you give the committee any examples of
    where capital restrictions were responsible for preventing a
    crisis or promoting growth?
        Mr. Taylor. No, I cannot personally give you examples, but
    looking at the many examples where capital controls have been
    applied, sometimes they change the maturity structure of debt,
    maybe more longer term, less short term. There is evidence for
    that in Chile. That has not, in my view, had an impact on
    crises. But it has also had disadvantages. There are some
    recent studies that show that those same controls made it more
    difficult for small firms to get credit, to get access to
    markets. So it had a bias against small firms in the country.
    So often these kinds of controls have impacts that you do not
    even know about when you are putting them on. There are always
    disadvantages, even studies that try to find and look for the
    benefits of a capital control, that it really was effective in
    stemming a crisis or in remedying a crisis. As I read the data,
    I do not see them used effectively that way. But even when they
    are used, you see the other harmful effects that come from
    them.
        Mrs. Biggert. Our U.S. financial service products are some
    of the most effective and most sophisticated in the world. How
    will increases in trade in financial services result in greater
    economic stability in these countries and what impact will
    greater access to capital have on Chile and Singapore? Maybe
    Mr. Mendenhall can answer that.
        Mr. Mendenhall. I will have to leave it to Under Secretary
    Taylor to talk about the specific economics of it. But I think
    there are several studies out there available, the most recent
    on coming out of the University of Michigan talking generally
    about the liberalization of trade in goods and the benefits for
    developing and developed countries alike. I apologize I do not
    have specifics for Chile and Singapore, but this particular
    study for example said that just for the United States that for
    services alone, a one-third cut in services restrictions would
    result in a gain for the United States of $150 billion. I think
    there are studies out there supporting, maybe not of the same
    magnitude, but supporting benefits for the average Chilean and
    Singaporean citizens as well.
        Mr. Taylor. If I could just add briefly, I think the
    Chilean economy is a real success story in Latin America. They
    have withstood lots of crises. A lot of that is because of the
    openness of the economy. In the financial services area, they
    are relatively open already, so the examples of the increased
    openness are smaller than in the case of Singapore. But the
    economic stability is improved when banks run more efficiently,
    when there is more prudential investments and better
    regulations. What we have found in Mexico and other countries,
    that the foreign investment, again whether it comes from the
    U.S. or other countries, improves the efficiency and the
    regulatory oversight in ways that are beneficial for economic
    stability.
        Mrs. Biggert. It has been about the last 10 years that
    Chile has had much more stability, isn't it? It seems to me
    that before that there was pretty wild fluctuation in their
    currency and the financial markets. Why is that?
        Mr. Taylor. The Chileans have chosen a number of good
    policies--the openness which is now even better with the FTA
    that is coming, but the also the policy with respect to keeping
    inflation down. They basically, it used to be they had hyper-
    inflation for many, many years, big ups and downs, triple-digit
    inflation numbers. In the early 1990s, they went to a policy
    that focused on getting inflation down. It has been very
    successful, but it is just one example of the improvement in
    policies that they have had.
        Chairman King. The gentlelady's time has expired. The
    gentleman from Massachusetts, Mr. Frank.
        Mr. Frank. Thank you, Mr. Chairman. I want to reemphasize
    we are not talking here--no one is arguing, I believe, that
    capital controls are always a good thing or they ought to be
    mandatory. We are talking about a very extreme argument on the
    other side that says they are never a good thing and they ought
    to be prohibited, and that no government democratically elected
    might be even allowed to experiment with them.
        Mr. Taylor, you keep talking about the cooling off period,
    but I am afraid the ice is in the eyes of the beholder here. It
    is not as cooling off as you say, because while you have to
    wait six months in the case of foreign direct investment and 12
    months in the case of foreign direct investment and 12 months
    in the case of portfolio investment to bring a complaint if you
    are an aggrieved private investor, in either case if you decide
    to bring it, in the first place that is the decision of the
    private investor--no government intervention can dissuade you;
    and secondly, your damages go back from the day it happened. In
    other words, the six and twelve month cooling off periods are
    cooling off periods when you can file your claim, but you do
    not delay the effective of this. So that a country that decides
    to impose controls on short-term capital, yes, someone might
    have to wait 12 months, has to wait 12 months before claiming
    damages, but if that private individual decides to claim
    damages, it is the absolute right of that private individual to
    go to the arbitration panel--there is no government role in
    this on either side--and the damages accrue from the first day.
    Isn't that accurate?
        Mr. Taylor. That is accurate if the controls on these
    particular types of capital last for longer than year and if
    they substantially impeded transfers, yes.
        Mr. Frank. Right. And of course, the definition of
    ``substantially impede'' is nowhere in the agreement. We have
    not been able to get anybody to tell us what that means, and it
    will be left to them. We ought to be very clear about this,
    because these are very important policy issues, as all the
    questions are made clear. But the ultimate determination is
    left to these private arbitration panels which can be triggered
    by private aggrieved individuals. So what is a substantial
    impediment would be left to that group.
        Now, you make a distinction here, which I am struck by,
    because I do not think you carried through, frankly, with it in
    policy terms, between foreign direct investment and portfolio
    investment. I think if we were talking about foreign direct
    investment, there would be much less objection here. You talked
    about providing funds for workers. Short-term capital flows--
    does our government really think that there are never times
    when a country, particularly one that might not have a well
    developed banking system--the gentleman from Illinois said,
    well, the problem was not liberalized capital flows; it was a
    poor banking system. But our problem is enforcing these capital
    flows when people have weak banking system, and it seems to me
    that is what--I see no indication you do not plan to do that in
    any case. But are there no cases where controls on the short-
    term capital flow in countries that do not have fully developed
    regulatory systems would be a good idea?
        Mr. Taylor. I think the important thing is they get the
    prudential regulations in place so that the chances of
    financial----
        Mr. Frank. Okay. Let me ask you this question. I accept
    that answer, but then the question is, does that mean that you
    will not be including these provisions in any free trade
    agreement with a country that does not have a well developed
    regulatory system financially?
        Mr. Taylor. I was indicating to Ranking Member Maloney, as
    we go through and consider future free trade agreements, we are
    going to have to consider what the countries want. As you say,
    these are democracies.
        Mr. Frank. Oh, let us leave aside what they want, because
    the question is whether you will be pressing, the United States
    will be pressing--is it a prerequisite for your insisting on
    these kind of provisions that the trading partner in this case
    have a well developed regulatory system? That would be
    particularly a problem, say, with the free trade area of the
    Americas. Let me ask you this specifically, does every country
    that would be encompassed in the FTAA have a well developed
    financial regulatory system, in your judgment?
        Mr. Taylor. I think, as you know, the FTA agreements that
    we are considering are with countries that we want to be doing
    all the things with respect to their policies.
        Mr. Frank. So there is no country that would be included in
    the FTAA that does not have a good financial----
        Mr. Taylor. Well, I hope that they can all improve and get
    better. But your question about whether we insist on this
    imposition, it is really not the way to think about it. We
    negotiate with a point of view which we think is a good point
    of view, a good philosophy. We have listened. We negotiated.
        Mr. Frank. Mr. Taylor, I am sorry to have to say this, but
    that is not true, and I know that first-hand. I have been in
    conversations with the Ambassador of Singapore. The United
    States market is the eighth wonder of the world. We have
    developed fortunately for us an economy that is extraordinary.
    Access to the American market, access to American capital is
    obviously enormously important, particularly when you were
    talking about bilateral agreements. The ability of an
    individual country to refuse to deal with America is quite
    minimal. I know as a fact that the Singaporeans would have much
    preferred not to have had this. They were for free trade. They
    did not want to give in to this, and I know this from the
    ambassador from Singapore, who sought me out when my colleagues
    and I objected in a letter that we sent to the Treasury, saying
    do not push for this.
        So I have to say I am disappointed by what I think is an
    inaccurate characterization you give of these negotiations. I
    think it is clearly a case where the enormous economic power of
    the United States was put in the service of an ideology and
    some economic interests, but I believe it was primarily the
    ideology, and that the Singaporeans assented. I will tell you
    this, and my time is up, but I think that probably also
    accounts for the fact that your testifying partner has been
    significantly less enthusiastic in this testimony than you have
    been. I think it is clear that in fact this is the Treasury
    Department imposing not just on Singapore, but on the U.S.
    Trade Representative.
        Thank you, Mr. Chairman.
        Mr. Taylor. If I could just answer briefly, these are
    negotiations. They are give and take. Different parties have
    different interests. That must be clear in every single
    negotiation that takes place, whether it is on a reduction for
    trade in a particular good or a particular commodity or whether
    it is trade in financial services or whether it is these
    issues. We had a lot of discussion in our government on these,
    and this agreement represents a compromise which was
    negotiated.
        Mr. Frank. I agree, but you have just acknowledged, I
    think, the United States and Singapore saw themselves as having
    different interests. I understand why the Singapore government
    felt they had to give in to you on this important point,
    although very reluctantly.
        Chairman King. Mr. Mendenhall, do you want to comment on
    the gentleman's observation on your level of enthusiasm?
        Mr. Frank. I would note, Mr. Chairman, that was not a
    volunteered intervention. I appreciate that.
        [Laughter.]
        Mr. Mendenhall. I generally have a penchant for
    understatement. I am quite enthusiastic about these particular
    agreements.
        Mr. Frank. I would hate to see you when you were bored, Mr.
    Mendenhall.
        [Laughter.]
        Mr. Mendenhall. Part of my silence on this issue is because
    I was not at the table for most of this. I am newly appointed
    to this position, and I observed much of it from afar. But I
    think the points that Under Secretary Taylor has made are
    correct. In fact, I know we fully endorse them. In our view,
    the particular provisions that we negotiated on, or that my
    colleagues have negotiated on capital controls strike an
    appropriate balance between the regulatory interests and the
    commercial interests. I think the points that Under Secretary
    Taylor has made on those points are quite powerful. Again, just
    a general comment on whether or not the United States was
    unilaterally dictating the terms of these agreements, I think
    that is--in fact, I know that is not the case. This was the
    result of a compromise, as were many other provisions in the
    FTAs. There were many things that we wanted to get at the end
    of the day.
        Mr. Frank. A compromise between our wanting it and their
    not wanting it on this one issue. That is all I would agree.
        Mr. Mendenhall. Again, to the extent that we wanted it and
    they did not want it, I defer to Under Secretary Taylor. But
    again, there are points of convergence and that is what the
    compromise is about. That is what the negotiation was about and
    that is where we ended up at the end of the day. Did both sides
    get everything they wanted in every aspect of these FTAs? No,
    probably not. This was a negotiated compromise. That is the
    nature of what a negotiation is for a free trade agreement and
    any other area.
        Chairman King. I would advise the gentleman from
    Massachusetts that is really an unfair standard to apply to
    witnesses to expect them to match your level of exuberance.
        [Laughter.]
        That is a very unique level, and witnesses can have other
    talents besides being as exuberant at the gentleman from
    Massachusetts.
        Mr. Frank. Well, if the majority would let me pick more of
    the witnesses, we might have a little more energy here.
        [Laughter.]
        Chairman King. The gentleman from Florida, Mr. Feeney.
        Mr. Feeney. Thank you, Mr. Chairman, and thank you,
    gentlemen.
        Earlier, one of my colleagues suggested that the
    restriction on capital controls might tend to favor U.S. banks
    and that investors would seek the protection provided by these
    agreements. Granted that that is certainly a possibility, isn't
    there also a corollary benefit that it will discourage
    countries that otherwise might be in a haste to exercise those
    capital controls on their own banks? And isn't there also the
    possibility that those countries will focus increasingly on
    sound monetary policy, good regulatory practices with respect
    to their own financial institutions? And isn't there a
    potential net positive effect on their internal mechanisms
    coming from doing the right thing with respect to U.S.
    investors and banks?
        Mr. Taylor. Yes, I agree with that very much. The controls
    and restrictions have benefits that sometimes go to particular
    individuals, but they have harms that are broad. You are
    pointing out some of the harms that can actually occur in the
    country themselves. We are focusing on rights for foreign
    investors, but the harms actually I think are more pervasive in
    the country itself. Just for example, short-term capital flows
    sometimes are bank loans, short-term bank loans. A lot of
    businesses need bank loans for various purposes. So if there
    are restrictions on those of any kind, it is harmful to the
    businesses that are trying to get the loans. That is just an
    example. So every time one of these restrictions is put in
    place, it has harmful effects. In fact, I think people would
    prefer not to use the restrictions and that is what we have
    found in the case of Singapore and Chile. They would prefer not
    to use them, and we gave them in this agreement an opportunity
    for flexibility in case they really had to in the future, but
    they were very reluctant to do it.
        Mr. Feeney. Mr. Mendenhall, I do not know how enthusiastic
    you can get about helping countries reform their banking
    regulation and fiscal policy and monetary policy, but maybe you
    can add to that.
        Mr. Mendenhall. I think in large part, it would be our
    policy that the countries should reform independently, even if
    what we do in the free trade agreements. The free trade
    agreements are a useful tool to prod them along, to lock in the
    commitments that they have already made.
        Mr. Feeney. And just so competition helps improve goods and
    services in countries, so it may improve regulatory practices
    with respect to financial institutions.
        Mr. Mendenhall. I think that is correct, and I think that
    has been our approach on our whole trade agenda. That is one of
    the reasons we are being so aggressive on our free trade
    agreements is we expect this competition for liberalization,
    which is why we are pursuing liberalization of financial
    services, both in the WTO and on the free trade agreement side.
    We might be able to get more or less in some areas, and make up
    for it or complement it in other areas. So I think that is
    right.
        Mr. Feeney. If I can, several of my colleagues here, and I
    think at least one of the professors is going to address this,
    has suggested that there is some huge difference between free
    trade practices and free capital flow regulatory issues. They
    have actually suggested that some of us free traders are not so
    free when it comes to letting countries regulate their own
    capital flow. But indeed, isn't there another way to look
    through the prism at this, and that is that to protect a
    country's ability to essentially confiscate or freeze the flow
    of capital actually encourages protectionism in those
    countries. What you are protecting is faulty monetary policy
    and bank regulations. Can't you look at it through the free
    trade prism?
        And finally, because I see my time is almost up, you will
    not get to respond if we wait to the suggestion that bilateral
    agreements somehow will ultimately interfere with the ability
    to deal with multinational approaches to free trade, so if I
    could have the gentleman weigh in on the first question with
    respect to aren't we really suggesting, some of my colleagues,
    that what we want to do is to protect bad regulatory behavior,
    (A); and (B) is it true that promoting bilateral agreements
    with friends is somehow going to undermine the ability to deal
    with multinational free trade throughout the globe?
        Mr. Mendenhall. Sure, I will address those comments in
    turn. I think the dichotomy between free trade and free
    movement of capital is a bit false. What we are really talking
    about is free markets, opening free markets. So that principle
    I think would apply equally to both free movement of trade and
    free movement of capital. The nature of those problems may
    differ. The free movement of capital and the regulatory issues
    related to financial services are complicated, in many cases
    more complicated that dealing with reductions of tariff
    barriers and that type of thing. But I do not think that
    changes the underlying fact that the free market principles is
    what we are trying to enshrine and promote in these trade
    agreements.
        On the point about whether, if I understood the question,
    is whether bilateral agreements, the pursuing of a bilateral
    trade agreement agenda undermines or undercuts the multilateral
    initiative--did I understand that question correctly? Okay. We
    do not believe that. In fact, we believe that they complement
    each other. One of the points I wanted to raise in my testimony
    was that this is certainly Ambassador Zoellick's philosophy and
    it is the philosophy that we are pursuing, that we are pursuing
    bilateral, regional and multilateral initiatives at the same
    time, precisely to encourage competition and liberalization. In
    fact, we are even doing it within the same region. We are
    pursuing free trade agreements with Central American countries.
    We just concluded the trade agreement with Chile. At the same
    time, we are pursuing the FTAA. We are engaging in these
    bilateral discussions because you can frequently make much more
    progress in a bilateral context than when you are negotiating
    in a multilateral context. But they all have value and they all
    complement each other in many ways. The advantage of the
    bilateral context is, one, you can make progress; two, you can
    tailor the specific provisions if you need to to specific
    problems that are in a country. You do not always get reduced
    to the lowest common denominator.
        Chairman King. The gentleman's time has expired. The
    gentleman from Vermont.
        Mr. Sanders. Thank you very much, Mr. Chairman.
        What I would like our guests to do, and thank you very much
    for being with us today, is, I am going to make some what I
    believe to be statements of fact. When you disagree with me
    with exuberance or not, just tell me where I am wrong.
        The United States believes, this administration, previous
    administrations believe very strongly in pushing free trade and
    globalized liberalization. This country today has a $400
    billion trade deficit, the largest in our history. We have $100
    billion trade deficit with China. In the last two years, we
    have lost 1.7 million manufacturing jobs, and at 16.5 million
    jobs, we now have the lowest number of manufacturing jobs in
    the United States in the last 40 years. Anything I have said
    that you disagree with? I do not see any disagreement, Mr.
    Chairman.
        Mr. Taylor. Just on the facts, of course.
        Mr. Sanders. Yes.
        Mr. Taylor. There is a causality that is implicit, but we
    can come back.
        Mr. Sanders. If you disagree with the facts, please, but
    you are not disagreeing with what I have said.
        You will not disagree with the fact that over the last
    number of years there has been a transition in our economy from
    manufacturing to service industry jobs, and that most service
    industry jobs pay workers less than manufacturing jobs. That is
    what is happening in the United States, which indicates to me a
    failure of so-called free trade. Let me quote from the New York
    Times of September 4, 2002. I think we can all agree that the
    flagship of free trade, the model that we looked at, is NAFTA.
    The New York Times, by the way, strongly supported NAFTA when
    it was passed; article, September 4, 2002--you will forgive me.
    I am, needless to say, excerpting. ``It has been two decades
    since Mexico committed itself to free trade reforms aimed at
    propelling this country into the developed world. But
    government statistics show that economic liberalization has
    done little to close the huge divide between the privileged few
    and the poor and left the middle class worse off than before.
    According to a recent government report, in the year 2000 half
    the Mexican population lived on about $4 a day, with scarcity
    shifting along with the population from rural regions to
    cities. Some 10 percent of Mexicans at the top of the economic
    period controlled close to 40 percent of the nation's wealth.
    Meanwhile, the 35 percent of Mexico's population that lives in
    the middle, with average earnings of about $1,000 a month,
    spirals slowly downward. The economist Rogelio Ramirez de la
    Oze, said that in the 1970s, when Mexico's population was 50
    million and the country had begun to enjoy the benefits of an
    oil boom, some 60 percent of Mexicans were middle and working
    class. Their numbers and buying power have declined
    dramatically since then,'' Mr. Ramirez said.
        In other words, free trade and NAFTA has failed for Mexico.
    It has failed for the United States' workers in the United
    States. I believe that if you look at what is going on in
    Argentina, what is going on in Venezuela, what is going on in
    Brazil and other countries throughout Latin America, you will
    find the same story.
        So my first question, starting off, and there are two
    questions I would like to ask, Mr. Mendenhall, is why are you
    here telling us that we should defend a policy which has failed
    American workers and failed the poor people and the middle
    class of developing countries? My second questions--of course,
    we are here dealing with financial services--let me quote from
    Business Week, February 3, 2003, quote, ``In the past year,
    Bank of America has slashed 3,700 of its 25,000 tech and back-
    office jobs, an additional 1,000 will go by March. Ex-Bank of
    America managers and contractors say one-third of those jobs
    are headed to India, where work that cost $100 an hour in the
    U.S. gets done for $20. Bank of America acknowledges it will
    outsource up to 1,100 jobs to Indian companies this year. My
    second question is, in terms of free trade in financial
    services, how many decent-paying, middle class jobs do you
    expect will be lost?
        Two questions, why are you telling us to expand free trade
    when it has been by and large a disaster for working people in
    this country and for poor people abroad? Number two, in terms
    of financial services, how many jobs will American workers
    lose? Mr. Mendenhall, could you start it please?
        Mr. Mendenhall. Sure. I do not know all the numbers that
    you cited in the beginning. I cannot take issue as to whether
    they are right or wrong. I will assume they are. I do not know
    the sources. I think there is, as Under Secretary Taylor
    started to explain earlier, there is a tendency, I think, to
    load too much onto trade, perhaps for the bad and for the good.
    Trade is often blamed for the world's evils and on the other
    hand, trade is often viewed by some as the panacea for all the
    world's ills. The true answer is probably somewhere in the
    middle. So when you talk about loss of manufacturing jobs or
    the other factors that you cited, Under Secretary Taylor is
    entirely correct that we have to look at the cause of those
    particular losses. So I do not know for sure what the causative
    factors are for those losses.
        Mr. Sanders. If I may, sir, thank you--but when the
    evidence is overwhelming that companies are laying off American
    workers and going to China and to Mexico, can you doubt that
    trade and this policy plays a significant role in limiting
    manufacturing jobs, cutting back on manufacturing jobs in
    America?
        Mr. Mendenhall. I can tell you that the United States----
        Mr. Feeney. [Presiding.] The gentleman's time has expired.
    Without objection, he is yielded another 30 seconds.
        Mr. Sanders. I thank the gentleman, but I would ask for
    roughly the same amount of time as some of my colleagues had. I
    am not going to go on indefinitely. Do we have a vote, by the
    way? Did I hear bells go off? Did anyone hear that? No.
        Mr. Feeney. We will try to let you know, but if we can, to
    answer that question, we will try to go on and stick to the
    five-minute rule. We do have another panel of witnesses.
        Mr. Sanders. Okay. Yes, I understand.
        I understand your point that trade is not the end all.
    There are other factors, but I find it very difficult to hear
    people keep coming forward when the evidence is overwhelming
    that for the middle class, working class in this country, and
    for poor people abroad, this policy has largely failed. Mr.
    Taylor, did you want to comment on that?
        Mr. Taylor. I do not think it has failed at all. I think
    you are pointing to some trends about manufacturing and
    services that have been going on for many, many years. Our
    productivity in manufacturing is increasing at leaps and
    bounds, so to provide the same number of products, workers are
    going into services, which the United States has a great
    comparative advantage; and some very sophisticated services,
    some very high-paying services. So I think that is something
    that is going on, and as long as it is being done in a way that
    is beneficial to workers and firms, it is fine.
        Mr. Sanders. It does not concern you that millions of
    American jobs are now in China, where people do jobs at 30
    cents an hour.
        Mr. Taylor. I do not think millions of American jobs are in
    China.
        Mr. Sanders. You do not believe that?
        Mr. Feeney. The gentleman's time has expired. The gentleman
    from Texas is recognized for five minutes.
        Mr. Hensarling. Thank you, Mr. Chairman.
        Mr. Secretary, when the Administration sits down to
    negotiate a trade agreement with Singapore, is the
    Administration there to advocate, negotiate on behalf of
    Singapore's interests or the U.S.'s interests?
        Mr. Taylor. No, it is on behalf of the U.S. interest.
        Mr. Hensarling. For those who wish to invest in Singapore,
    for those who wish to trade in Singapore, have you heard, have
    you seen any evidence, have you heard any evidence, or
    testimony that they prefer capital controls, or that they want
    to increase the risk of the loss of their capital?
        Mr. Feeney. Mr. Taylor and Mr. Mendenhall, if you would
    pull those mikes a little closer to you we could hear better
    and the recording secretary could hear you better.
        Mr. Taylor. No, I have not heard requests for capital
    controls from U.S. financial representatives.
        Mr. Hensarling. Mr. Mendenhall, in your testimony, you
    indicate that the U.S. provides a substantial portion of the
    world's financial services, which I think many members of this
    panel are aware of. You point to several statistics that show
    we run a trade surplus in certain aspects of financial
    services. I must admit I am not one who is concerned about
    trade deficits. For example, I run a trade deficit with my
    barber every month. I run a trade deficit with my grocer every
    month. I am more concerned about whether or not my income is
    increasing and whether I have enough income to pay my bills.
    For those who are concerned about the trade deficit figure, if
    we are running a surplus in many aspects of financial services,
    a trade surplus, can you speak to the impact of capital
    controls on the further export of U.S. financial services?
        Mr. Mendenhall. I can speak to it briefly. On the surplus
    issue, I think on the services side, not just financial
    services, but services as a whole, the United States is
    essentially running a trade surplus overall, as opposed to the
    trading goods sector. On the impact of capital controls, I can
    speculate what that would be. I would imagine the riskier that
    the investment would be in foreign markets, whether they be
    Singapore, Chile or elsewhere, if there is a high risk of
    capital controls being imposed that it would lessen the degree
    of investment and lessen the degree of cross-border
    transactions, and therefore reduce the surplus, would be my
    speculation.
        Mr. Hensarling. Mr. Secretary, can you speak, give us a
    little bit more detail about the regulatory transparency that
    has been negotiated in these two trade agreements?
        Mr. Taylor. The regulatory transparency in the case of
    Chile is one in which they have agreed to, for example, make
    formal notification if there is a change in regulation, so that
    becomes very clear and is not a surprise. In the case of
    Singapore, there is just more information put out about the
    regulations, more transparent in the sense of more public
    notice in general.
        Mr. Hensarling. Thank you.
        Mr. Mendenhall. If I could just say a word about that as
    well, the transparency provisions I think are fairly central to
    the financial services chapter. I know it is of critical
    importance to our own financial services industries. In many
    ways, it parrots what we do in the United States. We have a
    publication and comment period. We have time frames for issuing
    or responding to applications for permits for financial
    services and so on. The reason I wanted to come back to the
    point is because I got an earlier question dealing with how
    these agreements might promote stability in some of these
    countries. I think the transparency provisions by making the
    markets more open, promoting information sharing, promoting the
    formulation of good regulations--all of that I think
    contributes to the rule of law and the stability of these
    financial regimes. Thank you.
        Mr. Hensarling. Thank you, Mr. Mendenhall. In the few
    seconds I have left, Mr. Chairman, if I could simply state for
    the record, coming from Texas, which is a lot closer to the
    nation of Mexico than the state of Vermont, I can tell you that
    NAFTA has been an incredible success on both sides of the
    border. Approximately one out of six jobs in Texas results from
    export and trade, principally with Mexico. If you have traveled
    south of the border, you see how many people have been
    liberated from poverty because of the American investment along
    the border, particularly in the maquiladors.
        Thank you, and I yield the balance of my time.
        Mr. Frank. Would the gentleman yield for one second?
        Mr. Feeney. This is not the geography committee.
        The gentleman from New York, you are recognized for five
    minutes.
        Mr. Manzullo. Illinois is a long way from New York.
        Mr. Feeney. I am sorry. Mr. Manzullo, you are recognized.
        Mr. Manzullo. I appreciate it. Thank you very much.
        What was that, Barney?
        [Laughter.]
        It is good to see you here. I would like to see everybody
    here on one panel, because I would--it would be delicious if
    Professor Bhagwati were there and able to point for point meet
    with Ambassador Zoellick on the efficacy of these regional free
    trade agreements, as opposed to world free trade agreements as
    a whole. I do not know if I agree with his calling it a
    Leninist approach, but that certainly would make things pretty
    interesting.
        I have this question. I am the Chairman of the U.S.-China
    Interparliamentary Exchange. We have met with the members of
    the National People's Congress on five different exchanges now.
    We just came back from China in January. Mrs. Biggert and Mr.
    Saunders were with us. One of the problems in the U.S.-China
    WTO accords is the fact that even with the liberalization or
    the ability of the United States' financial institutions to
    establish a presence in China, there has been this incredible
    standard that the Chinese have been setting. I do not want to
    call it deposit reserves, but in terms of almost a separate
    licensing requirement. It is obviously a non-tariff barrier,
    but it is just not working to get our people in there.
        I know it is not related to the issue of capital flight or
    anything like that, but what have we learned from the fact that
    there perhaps is a lack of specific language in the U.S.-China
    WTO accord, and to take that lesson and put it in future
    agreements so that we do not have the continuous problem of
    fighting with the foreign government as to exactly what the
    reserve requirement is.
        Mr. Mendenhall. I think I am going to have to defer on that
    question myself. I would be happy to meet with you afterwards
    to talk about the specifics. I do not know the specifics of
    that.
        Mr. Taylor. Just briefly, the WTO agreements are of course
    much different than these FTAs we are talking about, which are
    regional.
        Mr. Manzullo. Regional.
        Mr. Taylor. Yes, but not only that, they get better
    agreements in some sense; more substantial tariff reductions.
    Perhaps that is the issue that Professor Bhagwati is concerned
    about. But the nature of the FTAs is they do get more specific
    about these kinds of things. In fact, these capital control
    issues we were talking about are just exactly the kind of
    deposit regulations you are referring to. In this free trade
    agreement with Chile, we have endeavored to reduce the
    likelihood that those would take place. It was very specific.
    That is one of the advantages of free trade agreements, or more
    general trade agreements. The WTO is not as substantial as
    these free trade agreements.
        Mr. Manzullo. But it could have been. I know, Mr.
    Mendenhall, you are the new guy on the block. I would love you
    to stop by the office and discuss this in depth, obviously at a
    later time. But there is considerable frustration going on.
    Why, when we entered into the China-WTO accession accord, and I
    know that is before you came on board, why can't you have just
    in the matter of--Mr. Taylor, if you want to answer this--why
    can't you have strict provisions with regard to that problem in
    banking reserves, as you would in a regional agreement?
        Mr. Mendenhall. I can answer the question at a certain
    level of generality.
        Mr. Manzullo. That is Okay. Could you pull the mike closer,
    Mr. Mendenhall?
        Mr. Mendenhall. Sure.
        Mr. Manzullo. Thank you.
        Mr. Mendenhall. I can answer the question at a certain
    level of generality because I do not know the specifics of the
    issue you are referring to. But I think the tendency in a
    multilateral setting is that everything tends to get sort of
    reduced, if you will, to the least common denominator. In a
    bilateral or regional setting, the trade-offs are a lot
    clearer. The wants on both sides are a lot clearer, and it is
    easier to just trade one for the other as a single undertaking,
    if you will. The WTO has a great advantage, of course, that the
    global trading community is there, but it has the disadvantage
    of making the trade-offs and the gamin of the system, if you
    will, must be more complicated, and it is just easier to get
    higher standards agreements, if you will, in a bilateral or
    regional setting.
        Mr. Manzullo. Okay. I appreciate that. That really goes to
    the guts of Professor Bhagwati's statement in there. Thank you
    very much. I look forward to meeting with you sometime later.
        Mr. Feeney. And thank you, Mr. Taylor and Mr. Mendenhall. I
    assume that if members of the committee have additional
    questions and would submit them in writing, that you will do
    your best to reply.
        Mr. Mendenhall. Thank you. I appreciate the opportunity of
    testifying today.
        Mr. Feeney. Thank you very much.
        We have another distinguished panel. While you are on your
    way up, I will try to introduce you briefly so we can get
    straight into your testimony and introductions: Dr. Bhagwati,
    Andre Meyer Senior Fellow in International Economics, Council
    on Foreign Relations; Dr. DeRosa, President of DeRosa Research
    and Trading, Incorporated; Dr. Henry, Associate Professor of
    Economics at Stanford University Graduate School of Business;
    Dr. Lackritz, President, Securities Industry Association; Mr.
    Tarullo, Professor of Law at Georgetown University Law School;
    and Mr. Vastine, President of the Coalition of Services
    Industries.
        Welcome. I think we have got your name tags set up in
    order. As soon as you get seated, we will invite Dr. Bhagwati
    to start his testimony.

      STATEMENT OF JAGDISH BHAGWATI, ANDRE MEYER SENIOR FELLOW IN
         INTERNATIONAL ECONOMICS, COUNCIL ON FOREIGN RELATIONS

        Mr. Bhagwati. Thank you, Mr. Chairman.
        I think a lot of what I am going to say has been partly
    covered by the morning's discussion, but I will still indicate
    some principal points to recap and bring my own emphasis to
    bear. I think there are three questions before this committee.
    One is should we seek to impose serious restraints on the
    developing countries' ability to use capital controls, just a
    general question. Two, should we do this as part of our trade
    agreements. And three, what can we even say about the wisdom of
    the specific provisions which we have in the two agreements
    before us? I will take up these issues in that order.
        First, on the general wisdom of putting restraints on the
    use of capital controls, I am not encouraging people----
        Mr. Frank. Professor Bhagwati, could you pull the mike a
    little closer to you please? Thank you.
        Mr. Bhagwati. On whether we should impose constraints, as
    against encouraging people to use these, we have to be very
    clear whether we want to restrain countries from using these
    kinds of capital controls. I think after the Asian financial
    crisis of 1997 and 1998, nearly all economists in my judgment
    and information, and the International Monetary Fund, publicly
    now, have become much more cautious about the freedom of
    capital flows unregulated, you know, total freedom like total
    free trade. I would distinguish between three different
    contexts to understand this. First, should we pressure
    countries that are not on capital convertibility at all, to
    hasten their progress to doing so? IMF and U.S. Treasury were
    in fact doing this prior to the Asian crisis.
        But both the crisis and the fact that India and China
    escaped it, I think as Under Secretary Taylor was somehow
    forgetful when one of you asked as to whether there were
    examples of people who did well by not going in for capital
    convertibility, and these are two gigantic countries, which
    have been outward-oriented on trade, on foreign investment
    coming into them--China more so than India, but India has
    caught up. They escaped the crisis, the contagion altogether
    and they survived. So we do have examples where countries were
    prudent, maybe excessively prudent, probably too closed--one
    can discuss that--but they really escaped it. So I think IMF
    certainly, and economists have become much more cautious and
    prudential compared to the pre-Asian crisis situation. Second,
    when you are more or less open--this is a different problem--
    when you are more or less open financially anyway, should you
    also not be prudent at the same time? The Chilean example with
    the Chilean tax, which might be looked upon as a token tax at a
    country level, was designed to moderate in-flows. So flows
    coming in, when they seemed too large relative to the reserves
    and to the fundamentals at hand--your export capabilities and
    so on--and there I would say, again, people concede everywhere
    that such a tax, as against a permanent capital control, is
    actually a good weapon to have. Not that you want to rush and
    in use it all the time, but it is something you want to be able
    to have as a weapon under your command.
        The third is a more difficult one, namely that when you
    actually have panicky out-flows happening, as part of crisis
    management, do you then resort to capital controls? That is a
    different problem, again. Now, the Malaysians, of course, used
    them during the Asian crisis, and there was more controversy on
    this one. Again, my own judgment from whatever I have studied
    on this problem, is I am inclined to agree with those who have
    actually argued that Malaysians did rather well out of it,
    compared to the countries which took the then-prescription of
    the IMF.
        In conclusion, I would say on the first question, we are
    far more conscious today about the wisdom of not taking an
    ideological or a financial lobby-driven position against the
    use of capital controls. I think today we certainly would be
    emphasizing in the classroom and in every course we will teach
    that, look, this is not on a par with free trade. I think one
    of the Congressman asked me, you know, why is this different?
    The reason it is different is that with trade, which I am a
    great proponent of, as the Congressman from Illinois pointed
    out, that is a very different kind of proposition. I say that
    if I exchange my surplus toothbrush with some of your surplus
    tooth paste, and we remember to brush our teeth before we go to
    bed, we are both going to get white teeth. And the possibility
    of our teeth being knocked out in the process is very
    negligible. But when it comes to the analogy on capital flows,
    it is obvious that really the analogy is like fire. You can
    use, as I have pointed out in my written testimony, Tarzan can
    roast his kill, but if he goes back as the Earl of Greystoke
    and he plays around with fire, he can bring his ancestral home
    down. So you have to be prudent. It is a very elementary point,
    and only ideologically one could be against it today. So I
    think that is number one.
        Now, two, putting any such restrictions----
        Mr. Feeney. Doctor, if I can, we have your written
    testimony, and unfortunately as have a number of distinguished
    witnesses.
        Mr. Bhagwati. Okay. Let me just make one point quickly.
        Mr. Feeney. Yes, sir. Wrap up.
        Mr. Bhagwati. On putting any such restrictions down in a
    trade agreement, I think the Under Secretary was right, that
    trade liberalization should include services. We have a general
    agreement on trade in services. But that is not the issue we
    are discussing. We are discussing whether we should have
    capital controls ruled out, and there it seems to me that there
    is a real problem about bringing this into trade agreements. It
    is not just Congressman Frank or me and others who are worried
    about this. Today, we have had problems, as you know, with
    Chapter 11 and NAFTA, if this is where overly liberal
    ideological views seem to have been taken on takings. And that
    got us into a lot of trouble.
        Today, all the NGOs are anti-globalizers. They are very
    concerned about post-financial crisis about what we are doing
    on the financial issue. If we put something like this into a
    trade agreement, no matter which trade agreement, that is
    immediately going to attract flack. So I think it is
    politically imprudent to mix up trade treaties with capital
    account controls. If you want to shove it into an investment
    agreement, fine, then more of the objections will go there, but
    trade is bad enough--Congressman Sanders was exaggeratedly
    pointing to its perils, in fact erroneously so in my view--but
    you have positions like that. You do not want to mix it up and
    make and over-burden your case.
        [The prepared statement of Jagdish Bhagwati can be found on
    page 51 in the appendix.]
        Mr. Feeney. Thank you, Dr. Bhagwati.
        Mr. DeRosa?

    STATEMENT OF DAVID F. DEROSA, PRESIDENT OF DEROSA RESEARCH AND
      TRADING, FREDERICK FRANK ADJUNCT PROFESSOR OF FINANCE, YALE
                          SCHOOL OF MANAGEMENT

        Mr. DeRosa. Good afternoon, Mr. Chairman and members of the
    subcommittee. I am David DeRosa. I am president of DeRosa
    Research and Trading, and I am an Adjunct Professor of Finance
    at the Yale School of Management, where I have taught
    international finance for the last six years.
        My testimony is going to be on my position on capital
    controls. In the middle 1990s and continuing up to the present
    time, a great many emerging market nations experienced
    cataclysmic financial crises. Many of these same nations had
    previously been identified as growth miracle economies.
    Examples are Mexico in 1994; Thailand, Indonesia, Malaysia in
    1997; South Korea, 1997, 1998; Russia, 1998; Brazil, 1998;
    Turkey, 2001; Argentina, 2002. These were devastating crises,
    much economic suffering ensued; inflation, unemployment,
    bankruptcies were widespread.
        Now, stock and bond markets plunged and in all of these
    cases, the national currencies depreciated greatly and the
    foreign exchange regime that governed those currencies were
    abandoned. The reaction to the crisis has been largely to
    blame--the international capital markets and in particular the
    foreign exchange market. Some say the afflicted countries were
    victims of capricious international capital flows. Hence, we
    are here today to discuss capital controls in the context of
    some trade legislation.
        I studied economics at the University of Chicago for 10
    years. I have a bachelor's and a Ph.D from the school in
    economics and finance. I have been a currency trader at a major
    bank. I have been an investment manager and I have been a hedge
    fund manager. At present, I am a member of the board of
    directors of two of the most successful hedge funds. That does
    not affect my opinion on capital controls. It just explains my
    experience.
        Now, I want to call your attention to this, because it is
    my sincere belief that much of what happened in the 1990s and
    the last three years has been totally misunderstood. Take this,
    for example: All of the above-mentioned crises that seems to
    have shaped our thinking, all except one, Malaysia, which I
    will come to, took place in economies that had some form of
    fixed exchange rate regimes. In fact, the climax of all of
    these crises were when the fixed exchange rate regime exploded
    or was terminated. Each crisis was marked by a sharp out-flow
    of capital prior to the moment when the fixed exchange rate
    regime was scrapped. Once it was scrapped, there was sharp
    depreciation in the currencies, sometimes as much as 70
    percent.
        In each case, the government replaced the fixed exchange
    rate regime with a floating exchange rate regime. And you know
    what? No more crises. No more crises. Once a floating exchange
    rate, no more currency crises. All of these countries had
    accumulated massive amounts of private and public debt
    denominated in U.S. dollars. So when the exchange rate
    depreciated, the local value of those debts magnified up,
    sometimes two or three times. Preceding the crises, an enormous
    amount of foreign capital flooded into these countries,
    sometimes buying local securities, sometimes as direct
    investment, sometimes as leveraged transactions. But most
    important, all of these trades, which are called carry trades,
    were really not investments per se in the country, they were
    investments in the fixed exchange rate regime. Under the
    umbrella of safety that they thought they had, people invested
    in these countries to get superior interest rates, hoping that
    the fixed exchange rates would preserve the value of their
    capital.
        History has shown that fixed exchange rate regimes are
    crisis-prone. Almost all of them have blown up. It is an
    endemic problem, and it is not just emerging markets, it is
    major countries as well--witness Bretton Woods and the exchange
    rate mechanism. The reason why currencies depreciate so
    violently when fixed exchange rate regimes are abandoned is
    that domestic dollar borrowers and foreign investors all rush
    to hedge their positions. So it is the case of a crowded
    theater, 200 fat men, somebody yelled ``fire,'' and it is a
    narrow doorway. Governments in crises almost always make these
    crises worse, if not considerably worse, by enacting bad
    responses that exacerbate the situation. Thailand, Indonesia,
    Russia, Brazil and Argentina stand out as especially poor
    examples of how to respond to financial crises.
        Now, we have this myth that Malaysia found a kinder and
    gentler way by imposing capital controls. The fact is, Malaysia
    imposed them 14 months after the crisis started. This was a
    spectacular case of locking the barn door after the horse was
    out. In fact, Malaysia also simultaneously pegged the ringgit
    at 3.8 to the dollar and that is where it is today. And
    subsequently, all of the other Asian currencies have rebounded
    substantially. What relief Malaysia got was----
        Mr. Feeney. Dr. DeRosa, if you can wrap up. Thank you.
        Mr. DeRosa. Right. It was simply because it pulled a fast
    one. It devalued the ringgit relative to its neighbors.
        So the point is that you do not really have to worry about
    these crises or capital flows. They are a function of fixed
    exchange rate regimes. You do not need the capital controls.
    They are a bad idea.
        Thank you very much.
        [The prepared statement of David F. DeRosa can be found on
    page 64 in the appendix.]
        Mr. Feeney. Thank you.
        Mr. Lackritz? I am sorry. Dr. Henry?

        STATEMENT OF PETER BLAIR HENRY, ASSOCIATE PROFESSOR OF
       ECONOMICS, STANFORD UNIVERSITY GRADUATE SCHOOL OF BUSINESS

        Mr. Henry. Mr. Chairman, members of the committee, my name
    is Peter Henry. I am Associate Professor of Economics at the
    Stanford University Graduate School of Business. I am also
    Faculty Research Fellow at the National Bureau of Economic
    Research. My research is funded by the National Science
    Foundation's Early Career Development Program. I have written
    extensively on the economic effects of capital account
    liberalization.
        Thank you for the opportunity to discuss the implications
    of my research for the financial services component of the
    recent U.S. trade agreements with Chile and Singapore. My
    testimony consists of three brief general points. Point number
    one, what is my position on the importance of free trade? Free
    trade in goods, also known as trade liberalization, is the
    linchpin of globalization. All countries can benefit from free
    trade because free trade allows countries to export those goods
    for which they are low-cost producers, and import those goods
    for which they are high-cost producers. This kind of
    specialization brings two specific benefits. First, countries
    get to consume goods at a lower price than would be possible if
    instead of importing the goods, the countries produced them at
    home. Second, specializing in the production of goods at which
    they are more efficient raises countries' gross domestic
    product.
        Trade liberalization is not costless, however. Liberalizing
    trade may cause unemployment by driving inefficient producers
    out of business. In principle, however, the overall gain in
    gross domestic product that result from free trade are
    sufficiently large to pay for the cost of retraining workers in
    redundant industries. In other words, all members of society
    can be made better off from trade liberalization when it is
    judiciously applied. Therefore, we should take the lead in
    promoting worldwide free trade by continuing to open our
    borders to foreign goods and encouraging other countries to
    follow suit. The recent trade agreements with Chile and
    Singapore provide a small step in the right direction.
        Point number two, what is my position on the importance of
    capital controls? A heated debate over capital account
    liberalization has followed in the wake of financial crises in
    Asia, Russia and Latin America. Opponents of the process argue
    that capital account liberalization invites speculative hot
    money flows, increases the likelihood of financial crises, and
    brings no discernible economic benefits. Some economists have
    gone so far as to assert that open capital markets may actually
    be detrimental to economic development. I believe that there is
    a serious flaw with such reasoning. This flaw stems from the
    fact that those who oppose capital account liberalization have
    failed to define exactly what they mean. Why is it important to
    define precisely what one means by the term capital account
    liberalization? The reason is that there are many different
    types of capital account liberalization. At a minimum, we need
    to distinguish between two categories: those that involve
    equity and those that involve debt.
        Consider first equity market liberalization--opening the
    stock market to foreign investors. My research demonstrates
    that three things happen when economies open their stock
    markets to foreign investors. First, the cost of capital falls
    for companies that are listed on the stock market. Second, in
    response to the reduction in their cost of capital, the
    companies that are listed on the stock market increase their
    investment in physical assets. And third, as a result of the
    increase in investment, productivity rises and the country's
    growth rate increases by more than 1 percentage point per
    annum. Since the cost of capital falls, investment booms and
    economic growth increases when countries liberalize the stock
    market. The view that capital account liberalization brings no
    real benefits seems untenable.
        Liberalization of debt markets, on the other hand, has
    often led to great difficulty. For example, excessive short-
    term borrowing in dollars by banks, companies and governments
    have played a central role in the onset of almost every
    emerging market financial crisis during the 1990s. In essence,
    the mismatch between the term structure of borrowers' assets,
    which were typically long-term and denominated in local
    currency, and their liabilities, which were short-term and
    denominated in dollars, placed these countries in an extremely
    vulnerable position. Any bad news that made the lenders
    reluctant to extend new loans was bound to create an immediate
    liquidity problem. So we have to distinguish between debt and
    equity. Equity market liberalizations bring about good results;
    debt market liberalizations are much more problematic.
        Point number three, and last point--the lessons for this
    and future agreements on capital controls. The evidence I have
    outlined in this report can be distilled in a few key lessons
    for the capital controls portion of the Chile and Singapore
    free trade agreements. First, the liberalization of dollar-
    denominated debt flows should proceed slowly and cautiously.
    This agreement, as well as all future agreements, should
    refrain from any language that inadvertently pushes countries
    into prematurely liberalizing dollar-denominated foreign
    borrowing. The second lesson is that all the evidence we have
    indicates that countries derive substantial economic benefits
    from opening their stock markets to foreign investors. There is
    no reason to think that Chile and Singapore will be any
    different in this regard.
        Thank you.
        [The prepared statement of Peter Blair Henry can be found
    on page 151 in the appendix.]
        Mr. Feeney. Thank you, Dr. Henry.
        Mr. Lackritz, welcome and thanks for being here.

     STATEMENT OF MARC E. LACKRITZ, PRESIDENT, SECURITIES INDUSTRY
                              ASSOCIATION

        Mr. Lackritz. Thank you, Mr. Chairman. It is a pleasure to
    be here. Thank you for the opportunity to testify. I am Mark
    Lackritz, president of the Securities Industry Association. I
    want to testify in very strong support of these bilateral free
    trade agreements with both Chile and Singapore.
        These agreements will result in increased commerce between
    our respective countries, and in both cases the already close
    economic relationships will be further strengthened, providing
    new opportunities for U.S. securities firms and additional jobs
    in the United States. Importantly, we believe these agreements
    are excellent precedents upon which to build and negotiate
    ongoing and future bilateral and regional trade discussions.
    Both agreements successfully achieve many of the securities
    industry's specific objectives, including, first, permitting
    100 percent ownership and market access. Both of these
    countries are open market and provide U.S. securities firms
    with full market access by the establishment of a subsidiary or
    the acquisition of a local firm. Since the conclusion of the
    1997 WTO financial services agreement, both countries have
    undertaken extensive liberalization of their financial services
    markets. These agreements not only lock in current levels of
    access, but also produce commitments by both countries to
    eliminate and reduce some of the remaining establishment
    barriers.
        In terms of specific commitments, the FTA would for the
    first time afford legal certainty to U.S. firms to establish a
    wholly owned affiliate in Chile to provide asset management
    services on a national treatment basis. Singapore also made
    commitment guaranteeing U.S. membership on the Singapore stock
    exchange, as well as for the acquisition of equity interests in
    local securities firms.
        Increasingly, services must be delivered through a business
    presence in the host country. As a result, the ability to
    operate competitively through a wholly owned commercial
    presence or other form of business ownership must be a
    fundamental element of any agreement. These agreements
    guarantee the ability of U.S. securities firms to enter into
    these markets through the establishment of a subsidiary or the
    acquisition of a local firm. Once established, U.S. securities
    firms will receive the same treatment as domestic companies.
    For example, the free trade agreement with Chile provides
    national treatment to U.S. asset management firms in managing
    the voluntary portion of Chile's national pension system, and
    the ability to manage the mandatory portion of the pension
    system without arbitrary differences between the treatment of
    providers. In Singapore, U.S. firms will now be able to compete
    for asset management mandates from the government of Singapore
    investment corporation.
        In addition, obtaining commitments on regulatory
    transparency was our industry's major goal in the agreements
    with Chile and Singapore. We view the provisions contained in
    these agreements as excellent, and view the FTAs as important
    precedents for transparency of future efforts. The specific
    financial service transparency commitments in the FTAs will
    require that rules cannot be adopted without appropriate public
    notice and opportunity to comment; that requirements and
    documentation for applications be clear; and that decisions on
    applications be made in a specified or reasonable time. The
    ability to freely transfer and process information is essential
    to the business of modern financial services firms. Indeed,
    many products such as instruments built around market indices
    that are vital to smoothing out risk, could not function
    without timely data flows. Nevertheless, too few countries have
    committed to this key link in the financial services
    infrastructure. In this regard, commitments by both Chile and
    Singapore mark a major step forward. Chile made no commitments
    in financial information in the 1997 GATT agreement, while
    Singapore made a limited commitment. The FTAs will now give
    U.S. firms the legal certainty to process and disseminate
    financial information both domestically and cross-border.
        As a general matter with respect to capital transfers, our
    members believe that restrictions on capital flows deprive both
    parties of the benefit of cross-border investment. This is of
    particular concern to financial services companies and others
    engaged in portfolio investment. We welcome the general
    commitment in both agreements to permit the free and immediate
    transfer of capital related to an investment. However, we
    regret that both agreements contain exceptions to this general
    commitment. Our members fervently hope that these exceptions to
    free capital movements will not form a template for future
    agreements.
        In conclusion, Mr. Chairman, we believe these agreements
    offer Congress another opportunity to secure open and fair
    access to foreign markets for U.S. firms and our clients. This
    pact will result in benefits to consumers and businesses in
    both countries, as well as globally. We look forward to
    continue to work with both this committee and the
    Administration in developing a fair, rules-based trading system
    that enhances U.S. economic competitiveness.
        Thank you very much.
        [The prepared statement of Marc E. Lackritz can be found on
    page 161 in the appendix.]
        Mr. Feeney. Thank you.
        Mr. Tarullo, please pull that mike close to you so we can
    hear you.

         STATEMENT OF DANIEL K. TARULLO, PROFESSOR, GEORGETOWN
                         UNIVERSITY LAW CENTER

        Mr. Tarullo. Thank you, Mr. Chairman.
        Mr. Chairman, I am struck by the fact that it is Chile and
    Singapore we are talking about here. Chile and Singapore have
    been among the most exemplary developing countries in terms of
    their economic policies, their financial policies, and the
    orthodoxy of those policies. The fact that both of those
    countries, neither of which have imposed capital controls on
    out-flows in recent decades, asked that they be allowed to
    retain some capacity to impose capital controls in exigent
    circumstances seems to me a reason why this committee and the
    Congress ought to take a moment and reflect upon the import of
    these capital control provisions as a template for future
    agreements.
        Now, why would Chile and Singapore, as I say, two orthodox
    exemplary sets of macroeconomic policymakers ask for an
    exception? I think it is because of the cumulative effect of
    not just the Asia crisis, but the Mexico crisis, and what they
    have observed over the last decade in an increasingly
    globalized and sometimes turbulent financial system. They want
    to retain the capacity, in an emergency, to do something that
    they otherwise have no intention of doing. The International
    Monetary Fund, which was certainly a proponent of full capital
    account liberalization as recently as seven or eight years ago,
    has just released a very careful study which shows how nuanced
    one has to be in determining when and how capital flows are
    going to be efficient and effective in developing economies.
        Why is it that capital flows do not have the effect in a
    developing economy that they do in the United States, where
    more or less untrammeled capital flows are indeed productive? I
    think it is because we are in that murky realm which economists
    call the world of second-best. Developing countries do not have
    deep and liquid capital markets, by and large. They do not have
    well regulated securities markets. They do not, by and large,
    have sophisticated supervision for their banking systems. For
    all of these reasons, the countries are not able to absorb
    capital flows, particularly shorter term debt flows, in the way
    that the United States or the United Kingdom could. That is the
    reason why Chile and Singapore want this insurance policy, and
    that is the reason why I think we need to pay heed to their
    policymakers, speaking for themselves and on behalf of other
    developing countries.
        What troubles me about the present template is that it is
    really quite absolutist. It really does not distinguish, as Dr.
    Henry is trying to do, among different kinds of capital flows.
    Indeed, I note that the investment chapter of the Singapore
    agreement mentions and includes as an ``investment'' bonds,
    debentures, other debt instruments and loans. Unlike the NAFTA,
    for example, it does not say such bonds, debentures, debt
    instruments and loans of longer than three years duration. It
    is any such bond, debenture, debt instrument or loan. That kind
    of painting with a broad brush seems to me not to incorporate
    the appropriate modesty that we all must have in assessing the
    operation of global financial systems in developing countries
    in the wake of all we have seen in the last decade.
        I am concerned that what we are witnessing here is a bit of
    a triumph of economic creed over economic evidence. What I
    would like to see is more of what Dr. Henry and others are
    doing, of trying to draw distinctions, to see how much we can
    learn, and then through appropriate channels such as the IMF
    and discussions in the G-7, to see if we can come up with a set
    of sensible nuanced standards--standards that are not just
    based upon the textbook finance that apply in the United
    States, but that are based on the real operation of capital
    markets in the murky second-best world of developing countries.
        I do absolutely believe that when the United States enters
    into trade agreements, it ought to be doing so with its self-
    interest in mind. But that self-interest needs to be an
    enlightened self-interest. By ``enlightened'' I mean that we
    promote rules which are going to redound to the benefit of all
    of our trading partners, which will produce a more growth-
    oriented, stable international economy in which the exports of
    the members of the coalitions represented by the gentlemen on
    my flanks today will be able to prosper. I do not think we have
    an interest in some sort of short-term asset grab, if it is at
    the cost of our ability to promote such sensible rules.
        Thank you very much, Mr. Chairman.
        [The prepared statement of Daniel K. Tarullo can be found
    on page 177 in the appendix.]
        Mr. Feeney. Thank you.
        Mr. Vastine?

    STATEMENT OF J. ROBERT VASTINE, PRESIDENT, COALITION OF SERVICE
                               INDUSTRIES

        Mr. Vastine. Thank you very much, Mr. Chairman. I am here
    to testify on the commercial advantages of the Singapore and
    Chile agreements, and explain why they should be approved by
    the Congress.
        U.S. financial services companies are committed to trade
    negotiations to remove barriers to trade and investment. In any
    form, these barriers are very extensive. We would be glad to
    supply lists by countries of the kinds of barriers our
    companies face. The industry's $6.3 billion trade balance in
    cross-border trade in financial services last year would grow
    if we could remove these barriers. Indeed, reducing barriers to
    U.S. services trade is our best hope to reduce the chronic
    goods trade deficit that Congressman Sanders has referred to.
        Indeed, in order to try to add some light to the statistics
    raised earlier by Mr. Saunders, there were 20 million new
    services jobs created in our economy between 1992 and 2002.
    That more than offset the loss of manufacturing jobs. It is not
    correct to think that those jobs are low-paid, poor jobs. In
    fact, there are some, of course, as there are in manufacturing,
    low-paid jobs in services. But the average annual earnings in
    services in 1999, which is the last year for which we have
    data, were $32,800 compared to $32,400 in manufacturing. So it
    is not true that services jobs in general on the whole are low-
    paying jobs. Just to add one more statistic, between 1990 and
    2001, U.S. total employment increased from 92 million to 115
    million in the private sector. That is not the evidence of a
    country that is being laid waste by its foreign trade policies.
        Singapore and the Chile agreements, to go back to the
    subject, deal with the trade agenda of financial services
    companies more thoroughly than any other trade agreement to
    date. The Singapore and Chile markets are small, but the
    agreements are important precedents. They should be approved by
    Congress because, first, they fulfill the negotiating
    objectives of the TPA Act. Secondly, they bind liberalization
    already adopted by the two countries. Thirdly, they make
    commitments to new liberalization. For example, the provisions
    in the Singapore agreement on banking give U.S. banks
    significant new rights to operate as qualified full banks in
    Singapore, and to create and join ATM networks. They include
    commitments to cross-border services trade in insurance. Both
    agreements allow U.S. companies to offer many more products
    such as reinsurance auxiliary services, including actuarial and
    other consulting services, marine aviation and transport cross-
    border, and brokerage services.
        They provide for freedom of financial information flows for
    firms like Reuters. They contain important commitments to
    freedom of establishment, that is to say direct investment. You
    cannot sell a life insurance policy to a Singaporean from an
    office in New York. You have to establish. As Mr. Lackritz said
    earlier, services trade is characterized by this need to
    establish, to enter a market, to set up your business, and to
    sell a product. This creates, as in the case of New York Life
    in India, a lot of new jobs in New York and elsewhere in our
    country. It supports the home offices of our companies.
        Next, the agreements contain extensive commitments to
    transparency, which are very, very helpful--indeed, a
    breakthrough. They contain new provisions for improved
    regulatory quality. They provide modest provisions, but
    important ones, for the movement of people for temporary
    foreign assignments, which is a very important way in which
    financial services are traded. Finally, the agreements have
    sound investment chapters, which include of course commitments
    to freedom of capital transfers. We join the Securities
    Industry Association in noting that the agreements have
    measures to compensate private investors in case a country
    controls capital movements. I would just like to point out that
    these measures can backfire against the country that wants
    them. Countries that reserve the right to use controls may risk
    chilling the investment climate to their own disadvantage. It
    is like putting up a sign on the highway into town, ``investors
    are welcome, but we reserve the right to keep your cash.''
        Finally, Mr. Chairman, we believe these agreements are in
    our national interest and the Congress should approve them.
    They fulfill the TPA negotiating objectives. They are the
    result of substantial industry consultation. They contain some
    real breakthroughs, like in transparency. They are good
    precedents for FTAs with larger economies. They can seriously
    increase our financial services trade, especially if broadened
    among other countries, and increase U.S. jobs and prosperity.
    Finally, they can help reduce the goods trade deficit.
        Thank you very much.
        [The prepared statement of J. Robert Vastine can be found
    on page 198 in the appendix.]
        Mr. Feeney. And thank you.
        Congressman Frank, if it is all right with you, why don't
    you take about 10 minutes and then I will defer to you, and
    then I will conclude if we still have some time and interest.
        Mr. Frank. Thank you, Mr. Chairman. I appreciate this.
        Let me say, I was pleased to hear Mr. Vastine say that this
    goes much further in terms of accommodating the prudential
    interests than any previous treaty. I think that is a far more
    accurate description than Mr. Taylor saying, oh, it is just
    what we have always been doing. I think Mr. Taylor
    significantly understates the difference.
        I was particularly interested in Professor Henry's
    distinction. I welcomed it, with regard to debt versus equity.
    To some extent, I think that they are overlapping categories.
    There are short-term, long-term. There is foreign direct
    investment in portfolio and there is debt and equity. They have
    substantial overlap. What strikes me, Professor Henry, is that
    the interesting thing about these provisions is they do not
    make that distinction that you so carefully made. I wonder if
    you would care to comment on whether or not when we do this, we
    ought to take those fundamental differences into account.
        Mr. Henry. One of the reasons that I wanted to point that
    out was actually when I read through the agreement myself, the
    chapter on investment, it struck me that there were two
    separate issues. One issue is to what extent do you actually
    require a country to open up to various kinds of investment,
    and that issue does not seem to be addressed at all in the
    current investment agreement. What the current investment
    agreement addresses is really the second issue, which is given
    the decision to open up to certain kinds of investment, how do
    you treat foreign versus domestic holders of a given asset? The
    point that I just wanted to make, just so it would be on the
    record and people can think about it, is that I think the first
    point, the extent to which we actually require or possibly
    inadvertently push countries to open up to certain kinds of
    investment prematurely, is something that we should move away
    from.
        Mr. Frank. And again, the problem I think many of us have
    with these sets of treaties is that they do not make those
    distinctions. There were things--nondiscrimination, national
    treatment--a number of these things--access to ATMS--which are
    very good things. The point that Professor Bhagwati made, who
    has been a very strong support of free trade, is that the
    danger here is that this will undercut precisely the kind of
    support for trade that we wanted.
        Mr. Tarullo, one other point you noted, because again Mr.
    Taylor keeps saying this is just more of the same, you noted
    that with regard to NAFTA I think it was, there was a three-
    year requirement that is not here in this treaty. Is that
    correct, with regard to bonds, et cetera?
        Mr. Tarullo. Congressman Frank, there are a number of
    differences between the NAFTA provisions covering investments
    and those in the Singapore agreement. I am not able to get a
    copy of the Chile agreement. Apparently the Administration has
    not formally released it, but I gather it is pretty much the
    same. The one difference I mentioned in my testimony, which is
    that the definition of investment in NAFTA covers debentures,
    bonds, other debt instruments which are of longer than three
    years duration. Obviously, that was distinguishing between
    shorter and longer term. Another point of difference is----
        Mr. Frank. And here there is no such distinction.
        Mr. Tarullo. Not that I am able to find, sir. No.
        Mr. Frank. I was told there is not, that there is no short
    term, long term, or any other kind of distinction.
        Mr. Tarullo. The second point--there are a number of
    distinctions; we do not want to go through all of them here--
    but a second distinction is that the NAFTA explicitly
    incorporates IMF standards. Whereas, this agreement, at least
    with respect to the investor-state dispute settlement, seems--
    --
        Mr. Frank. And the IMF does allow for certain kinds of
    exceptions.
        Professor Bhagwati, I want to go back again to the
    experiences that we have had, because again I know no one is
    arguing for a regular reliance on capital controls. But would
    you talk some more? We have had some dispute about the East
    Asia experience in particular. Would you just talk a little bit
    more about what we learned from East Asia about particularly
    short term, hot money, portfolio investment, and how it is
    covered in this treaty?
        Mr. Bhagwati. Just to keep matters short, I think there is
    a diversity of experience there. South Korea was sort of caught
    up by the flu that came from Indonesia and Thailand. Thailand
    was a little weaker than Indonesia was, but essentially I think
    what happened was that despite relatively strong fundamentals
    compared to, say, Mexico or South American countries, these
    countries suddenly experienced massive out-flows. So it was in
    fact panic. Now, in economic theory, we do recognize that even
    when you are strong, you can have panic withdrawals simply
    because of things like what we economists call in jargon
    asymmetric information and so on. There are lots and lots of
    reasons why one could have this. DeRosa would have probably
    learned this as destabilizing speculation at Chicago, but it
    does occur. This is certainly did occur.
        So it had nothing to do with mismanagement or something
    like you had, you know, tremendous excess spending, the kind of
    thing which broke out in Mexico in 1994. So in that sense, it
    was really I think a classic case where you really learned that
    systems could in fact collapse under this kind of regime. So I
    think that is one lesson that we have learned. So we should no
    be too complacent, Congressman.
        Mr. Frank. Thank you. I would just note, I understand there
    are legitimate differences here. But to impose one particular
    view of what is at best a very hotly disputed thing, and to
    tell other governments that the price of dealing with the
    American market on these terms is to acquiesce to it seems to
    me a mistake.
        I have one final question for Mr. Lackritz and Mr. Vastine.
    We tend to get involved in two ways here. One, we negotiate
    treaties as to what kind of investments go, but when countries
    get into trouble and are not able to pay off either through
    sovereign debt or through other kinds of debt, our government
    also gets involved. Does this preference for a complete laissez
    faire, free trade, pure let the market work approach apply to
    when the trouble starts? Should we be equally saying, okay, the
    United States will run interference for you, and we will create
    for you absolutely open areas to invest in any of these
    countries. However, if having done that, you get into any kind
    of trouble and there are not payments et cetera, you are on
    your own. Should that be part of the deal, Mr. Lackritz?
        Mr. Lackritz. Well, I think you are referring to sort of
    sovereign debt restructuring.
        Mr. Frank. No, I am referring to--no, there are other
    things. There is sovereign debt restructuring. There is the
    United States lending money. There is pressure on the IMF. You
    know, there are a whole range of things, not sovereign debt
    restructuring only. I am talking about whether or not the
    United States Treasury, whether it is Argentina or Mexico or
    any other country, ought to get involved and say, alright,
    let's get involved and let's try and increase the flow of
    funds, partly so that the American investors can get their
    money back out.
        Mr. Lackritz. First of all, I think that what you are
    talking about, first of all, we favor having private
    contractual mechanisms to work out these kinds of situations.
        Mr. Frank. So you do not want any United States government
    involvement?
        Mr. Lackritz. And the involvement of the government
    obviously is helpful in those circumstances, but----
        Mr. Frank. But you would be opposed to it as an
    interference with the free market?
        Mr. Lackritz. I was not saying----
        Mr. Frank. You want the right to go in unimpeded. If you
    want to go in on your own, shouldn't you stay on your own once
    you are in there?
        [Laughter.]
        Mr. Lackritz. Well, conditions change, as you know.
        Mr. Frank. Oh, yes, once you have your money in there, they
    change.
        [Laughter.]
        Mr. Lackritz. I think you have to look at this from a
    longer-term perspective, from the standpoint of, how do we
    improve the flows of capital.
        Mr. Frank. No, that is a separate issue. I understand that.
    But I really will be honest, you know, Mr. Tarullo said there
    is a question of a creed intervening here. Let's put it on the
    table, there is also a question of whether greed is
    intervening. Obviously, people have a right to pursue their own
    interest, but I do not think it is in America's interest, by
    the way, to gain every short-term advantage for every
    commercial interest. We have an interest in stability. We have
    an interest in democracy. And the question is, frankly, are you
    not being inconsistent in being free-marketers when it comes to
    put the money in, but somewhat more mercantilist when it comes
    to you getting it out? Mr. Vastine?
        Mr. Vastine. I do want to respond to something you said
    earlier, characterizing my statement that these agreements gave
    more attention to financial services and other services, all
    other tradable services than previous agreements. Listen, the
    capital transfers provision of these agreements is a very small
    element.
        Mr. Frank. Could you get back to the question? I was just
    trying to say that you and I agreed that this is more different
    than previous ones than Mr. Taylor says. But what about the
    differential standards on the money going in and the money
    coming out?
        Mr. Vastine. Well, the market should be encouraged to work.
    Countries should be encouraged to take fundamental steps, not
    surface, not arbitrary, not administrative steps, to try to
    cure their international payments problems. Those are the real
    cures.
        Mr. Frank. I understand that, and that is a good answer if
    somebody asked you that question. But the question I had was,
    when you have taken advantage of these treaties and freely
    invested short-term, long-term, and trouble comes up, should I
    not just say, well, I will be interested to watch that because,
    you know, you took advantage of the market and the market has
    its bumps and its ups and its downs.
        Mr. Vastine. And some Treasuries take that point of view.
        Mr. Frank. What do you want them to take? I understand
    that, but what would your position be? Would you say to the
    Treasury, please, let's not be inconsistent here; the free
    market should work and we went in eyes open and we knew what we
    were getting into; let's not hear any talk of bailouts or
    federal government pressures for restructuring.
        Mr. Vastine. That is why this agreement provides a
    mechanism. If flows are stopped, the agreement does indeed
    provide a mechanism, a rather complex one and somewhat delayed
    one, to make investors whole. So in theory, there would not be
    any need for the government to involve itself.
        Mr. Frank. Unfortunately, the way to make investors whole
    would be, and I think this is a point that others have made--
    Mr. Tarullo and others--it would make investors whole by taking
    from a fairly poor country money that would otherwise be
    available for some basic services.
        Mr. Lackritz. Could I just respond to that?
        Mr. Feeney. Why don't we let Mr. Lackritz and Mr. Vastine,
    and then we are going to go the gentleman from Illinois.
        Mr. Lackritz. Thank you, Mr. Chairman.
        Mr. Feeney. Mr. Lackritz?
        Mr. Lackritz. I think the point that you are raising,
    Congressman, is an excellent point, but I would only refer you
    back to Emerson's notion that a foolish consistency is the
    hobgoblin of small minds. That is why we are trying to be
    pragmatic and practical here as well.
        Mr. Vastine. I guess my last point, Congressman, is that I
    cannot quote Emerson. I could give you a little Mark Twain on
    ``lies, damned lives, and statistics,'' but I will not do that.
    I would just like to caution that we should not be cavalier or
    presumptuous in thinking that the Chileans and the Singaporeans
    have weak regulation, and are not sophisticated negotiators.
    They are very sophisticated.
        Mr. Frank. I agree. One second here, I just want to say to
    Mr. Lackritz, to modify another quote, reference to Emerson in
    that sort of a situation is the last refuge of people who do
    not have a logical answer for an inconsistency.
        Mr. Feeney. Well, I thought we were talking to economists.
    We expect some inconsistencies, don't we?
        The gentleman from Illinois.
        Mr. Manzullo. I have a son studying English and poetry and
    Grove City, and he fell in with the libertarians and now he
    wants to double major in economics, so he can quote Emerson
    along with the economists.
        First of all, I am sorry I could not listen to the
    testimony of everybody, but it really ties into the
    constituents I have back there. There is a very skeptical mood
    in Congress with regard to any new free trade agreements, based
    upon the fact that there are not empirical studies that can
    justify economic theories. Members of Congress are elected by
    real constituencies, and not theorists.
        Let me give you an example. We have got a huge war going on
    with massive waivers of the Berry amendment by the Secretary of
    the Air Force, that is allowing Russian titanium to go into
    engines on our military aircraft. The waivers are granted ex
    parte. There is no notice. These are strategic metals, and
    therefore in the area of procurement. As a person who calls
    himself a free trader, we have looked upon the $300 billion in
    procurement in this country as a way of leveling the playing
    field. In other words, if the local manufacturers can get
    contracts for U.S. consumption, paid for by U.S. taxpayers'
    dollars, then that is the way to get a good share and to
    maintain a base, especially in the area of strategic metals.
        In examining these free trade agreements of America, the
    new FTAA, the Singapore and the Chilean agreements, our U.S.
    procurement is opened to these countries, and they can
    manufacture goods obviously a lot cheaper than our people, by
    providing nondiscriminatory treatment. In other words, if
    somebody from Chile wants to make a tank tread or tank turret,
    they can come in, bypass the Berry amendment, and again add to
    the hollowing out of manufacturing that is going on. I asked
    one of the assistant USTRs, and I have tremendous respect for
    Bob Zoellick. I do not think he is a Leninist, Dr. Bhagwati,
    even though the theory may have been Leninist. I am just
    teasing you, you know that.
        But I said, do you have any quantitative evidence as to who
    wins and who loses when we open U.S. procurement to foreign
    countries? In other words, are there any documents out there
    that show how much U.S. companies are buying of procurement
    from other countries, and how much other countries are buying
    of procurement from the United States. I was told the
    statistics do not exist. If the statistics do not exist, then
    why do we proceed with going ahead with these new agreements
    that leave the procurement open and further hollow away at our
    manufacturing base in the United States? I know this is on
    services and services are extremely important because the more
    liberalization of services you have, the merchandise follows
    after that. That is after the Vastinian theory put forth in a
    Cato article that Mr. Vastine published about three years ago,
    and that is when we first got involved in this. Does anybody
    want to tackle that question, take a look at it? Professor, I
    know you would like to.
        Mr. Bhagwati. I do not know of any empirical studies
    because procurement has usually been for one's own people, so
    that you would have to have an anticipatory study--you know,
    what would happen if, which would be very problematic. But I
    think I would just sort of make one response to this. This is a
    matter of opening up your system to more trade, just like the
    rest of the system. Procurement has been usually, even in the
    Uruguay Round agreement, I mean, that was kind of optional for
    most countries, I think, who signed onto it. But it is not in
    the regular agreement. It is on the annex.
        I would simply say that as more countries do that--I mean,
    obviously we are not going to get much out of these two partner
    countries in an FTA, but as we open it up and make procurement
    open to everybody around the world, and in the major countries,
    we will gain as much as we give, even looking at it on the
    terms in which you specify.
        Mr. Manzullo. But that is theoretical. You do not have
    any----
        Mr. Bhagwati. Well, we are pretty competitive, Congressman,
    so I would say we would expect to win a fair amount.
        Mr. Manzullo. But if that is the case, then the Chinese
    could come in and make all of our aircraft. They could make
    everything for us at a cheaper cost. Currently, if a document
    is shipped from the United States, with the exception of
    something that is bonded going to Mexico, because we know it is
    coming back, and with the exception of the 62.5 percent, NAFTA
    content in automobiles, we have no way of knowing how much
    foreign content exists is in an item that is shipped as a U.S.
    export. We have to study that because, you know, I lost 10,000
    manufacturing jobs in the congressional district that I
    represent in the past two years. So has the Speaker. His
    district is the mirror image of mine. Rockford, Illinois, which
    is in the center of the congressional district I represent, led
    the nation in unemployment in 1981 at 24.9 percent. And now, it
    is pushing 11 percent and we are losing more and more
    manufacturing jobs. These jobs are not coming back. So we are
    taking a look again at free trade being fair trade, and we are
    trying to make sure that what is touted as something that is
    made in America actually has American parts.
        If I may indulge the chair for a minute or so.
        Mr. Feeney. How about you take another two minutes?
        Mr. Manzullo. Okay. Thank you very much.
        In October of 2002, the Congress passed a bill that would
    authorize Boeing aircraft to lease to the United States 100
    767s, retrofitted as KC-135s, which are the fuelers that haul
    the fuel. Included in that legislative language, was a Berry
    waiver. I have scheduled an April 30th hearing on this before
    the Small Business Committee. I have held a meeting with the
    principals of this hearing this past week, along with Duncan
    Hunter from the Armed Services Committee. The question became,
    this is a noncompetitive contract; it is done by the grace of
    the U.S. Congress to help out Boeing aircraft. At the same
    time, with all the Berry waivers in there, we do not even know
    how much of that aircraft would be U.S.-content. In fact, Pratt
    and Whitney were at that meeting, and on the military aircraft
    they are selling, not only is there Russian titanium, but the
    drive shafts are made of nickel coming from Japan. Nickel is
    also a strategic metal that is covered under the Berry
    amendment.
        The reason I bring this up is the fact that, and I know you
    are testifying on services, and services are critical, and
    those who are not free traders in service do not understand
    that unless the service industry gets way out front, it is the
    service industry that pulls the manufacturing component behind
    it--so I know that you all have different views on this, but I
    accept that basic theory. Bob Vastine, you have been a real
    mentor to me on that, and Professor, I have read your stuff. I
    will read the testimony of each of you. But if anybody has
    anything they want to send me with regard to that, please do
    not send it through the mail. Call our office, and we will give
    you the fax number.
        Mr. Bhagwati. I would be glad to do that.
        Mr. Manzullo. And thank you very much for giving me the
    additional time.
        Mr. Feeney. Thank you. Obviously, this is a very important
    issue to Mr. Manzullo and his constituents. If any of our
    distinguished panel has anything that they can assist him with,
    I am sure he would be grateful and so would the committee.
        I just have one or two questions before we wrap up and let
    everybody go for lunch. First of all, I want to make sure that
    there are six other people that are engaged in the same premise
    I am, and that is that in general, with some exceptions, Adam
    Smith was right and free trade is best for both parties
    involved. Does anybody want to raise their hand?
        Mr. DeRosa. Absolutely.
        Mr. Feeney. Mr. DeRosa, maybe you can start, then, if we
    all start with the same basic premise, it seems to me that the
    history of both undeveloped, developing and highly developed
    countries is based on a couple of things--certainly being at
    peace is helpful--but in terms of things that you can help
    internally with respect to domestic policy. They are prudent
    monetary policy; respect for the rule of law; respect for
    property rights, both real and intellectual; relatively low
    marginal tax rates; and transparency in terms of the way the
    country does business. These help generate prosperity within a
    country, but is it also true to say that those policies attract
    capital? That is part one.
        And then number two, and then I will open it up for some
    other folks to respond, with respect to this question about
    basically restricting or freezing capital. This is part two of
    the question. Surely, regardless of whether you come down as an
    absolutist, that it should never be done or allowed in these
    particular trade permits, or whether we should always allow
    countries free rein, surely most of the panel will agree that
    there is going to be a risk associated with investment in
    nations that can essentially restrict, or at least temporarily
    nationalize capital.
        And so going to Dr. Henry's distinction, which is sort of
    the moderate position as I review the testimony, can you attack
    the problem based on Dr. Henry's testimony? If I want to create
    a widget manufacturing plant and invest $100 million, am I more
    or less likely to invest in a country that is prone or able
    under a trade agreement to nationalize the $100 million
    investment in my manufacturing plant? And if I am less likely,
    and I assume we all agree that I am less likely to make that
    investment, why would we in terms of incentives for investors,
    because after all capital is the most liquid and the most
    morally neutral thing I know of, why would we be more likely to
    disincentivize investors on the debt area, as opposed to the
    equity area? Maybe Dr. DeRosa, you can start.
        Mr. DeRosa. Thank you. The reason that these countries that
    we speak of got in trouble was not necessarily a distinction
    between debt and equity, but the denomination of the financing.
    But they did get in further trouble by using excessive amounts
    of short-term debt, so when the crunch hit, they could not find
    investors to roll the debt. The reason why this enthusiasm for
    short-term debt--it is an interesting question, because I
    indicated earlier that in every one of these cases, you can
    trace back almost signature errors that governments did in
    responding. In the case of at least Thailand and South Korea,
    and I think other ones as well, but I know in those cases,
    there were government policies before the crisis to force or
    greatly encourage local companies to borrow short term and
    never long term. The title for this, the name for this is
    called window guidance. Thailand had effectively had a
    government institution set up to encourage companies that
    borrow internationally only to borrow short term. The same was
    for Korea.
        So it is a combination of a squeeze on the currency and
    also a squeeze on the denomination. But your characterization
    of what it takes for growth is something that I have great
    sympathy for. These are things that actually are in Adam
    Smith's Wealth of Nations, about what is the proper role of the
    government in terms of the rule of law, property rights, things
    like that. Essentially, that is what went wrong in the early
    stages after the Soviet Union disintegrated. Why didn't growth
    come earlier? But I come back to this basic premise that
    capital really is not as fickle----
        Mr. Feeney. Well, and in Latin America, agrarian reforms do
    not help if every new regime every three years nationalizes
    property and institutes a new set of reforms.
        Mr. DeRosa. Absolutely. And this is what is going on
    wholesale in Venezuela right now. This is why a country that
    ought to be prosperous is in a tailspin thanks to the leader of
    Venezuela. But you know, it all comes back to this. There is
    this central thing that I keep saying to people. Capital really
    is not as flighty as people think. The hot money that people
    describe, thinking that it is going to rush in and rush out,
    every case that I know of, and I have studied all of these
    crises in detail; I wrote a book on this; I write columns about
    this. It is all associated with the nature of the foreign
    exchange regime. It is always traceable back to a fixed or a
    creeping fixed exchange rate regime. People are trying to game
    the system. The locals are borrowing in dollars because dollar
    interest rates are lower by definition because of country risk.
    Foreigners are investing in the local currency, and sometimes
    on a leverage basis.
        When the situation becomes untenable, then when the
    exchange rate regime goes to break, that is when you get this
    massive outflow of capital. Once the exchange rate starts to
    float again, this phenomenon does not--I do not know of a
    single case; I have studied a lot of economic history, have
    written a lot about economic history--all of these things are
    coming out of the exchange rate regime. That is why the crises
    occur. No country that I know of has gone from a fixed exchange
    rate regime to a floating regime in the last 20 years and
    suffered a second crisis. So all this talk about putting in
    capital controls is irrelevant and damaging, because it is
    unnecessary. It is unnecessary. Countries do not just fall over
    dead in their tracks. They do not just roll over and collapse.
    That is not the nature of modern economics as we know it. You
    can always dissect it. You can always do a post-mortem and in
    all of these cases that we are talking about, where capital
    flight is a problem, go back and look at it carefully and you
    will see it is coming out of the disintegration of a pegged or
    fixed exchange rate regime.
        Mr. Feeney. Thank you, because it would be a waste of some
    superior intellect and talent to speak at length to a freshman
    Congressman from Florida, if each of you will take two
    minutes--Dr. Bhagwati, and then maybe we will skip Dr. DeRosa--
    thank you for your lengthy--and maybe we will just conclude and
    thank you for your participation.
        Dr. Bhagwati?
        Mr. Bhagwati. Thank you, Congressman. Just to respond to
    your last question very briefly, what we are dealing with is
    the ability to use capital controls in a crisis and what the
    consequences would be. I think to treat that as something like
    confiscation. I do not think that is what the gentlemen who are
    going to invest are going to look at it that way. I think the
    probabilities are on the low side. What we are saying is you
    have to allow for it and let these countries really be able to
    exercise this option. I do not think anybody is going to be
    affected by that in terms of investing in one country rather
    than another. So I think it is, my answer to you is, well, the
    threat of nationalization, et cetera, of course it is something
    we would all react to. We would not want to put money there.
    That is not what we are dealing with. So I would say relax on
    that one and take this out if you can.
        Mr. Feeney. Thank you.
        Dr. Henry?
        Mr. Henry. Let me start by saying that free trade is one of
    the best means we have for actually increasing global welfare,
    so we should almost always in all circumstances continue to
    push for free trade on a fair basis. With respect to free trade
    in capital, by and large free trade in capital also has the
    potential for the same kinds of effects. Where we need to be
    careful is when we are dealing with systems in which there are
    other distortions, for example a fixed exchange rate regime, as
    Dr. DeRosa mentioned. In those circumstances, we want to be
    careful about inadvertently pushing countries into undertaking
    policies which, given those other distortions in the system,
    could prove very damaging in certain kinds of situations.
        So for example, if you have a fixed exchange rate system
    and people are tempted to borrow in dollars because interest
    rates are low, what we have seen time and time again is that
    the people who actually borrow in dollars are people who are
    not actually earning dollar revenues, and that creates a real,
    very explosive situation when in fact the exchange rate regime
    comes to an end. So what we should do in those situations is
    really force people to internalize those risks and recognize
    that in certain situations where there are obviously other
    distortions, the first best policy--complete free trade in
    capital--might not be the best answer. In particular, since
    history has shown us empirically that these debt market
    liberalizations seem to get countries in trouble, we should
    just be very wary of that.
        In general, I agree with your point. Anything which creates
    a disincentive to capital to go into a country is going to lead
    to less investment. But we should remember that what we want is
    efficient investment, not just investment.
        Mr. Feeney. Or higher interest rates or expectations of
    return on capital.
        Mr. Henry. That is right, but sometimes higher interest
    rates or implicit interest rates are in fact warranted because
    there are risks involved. We should in general move to a
    situation that is efficient, to use an economist's term, ex
    ante--before things happen--where we get people to actually
    internalize those risks and generate efficient investment.
        Mr. Feeney. Thank you, doctor.
        Dr. Lackritz?
        Mr. Lackritz. Thank you. I appreciate the upgrade in my
    degree.
        I think going to your point, Congressman, that obviously
    capital flows to countries which have institutions where there
    is the rule of law, where there is an openness and a
    transparency, and where there is a culture and a tradition of
    where there is an expectation of returns. At the same time, the
    market is fairly efficient, and where these institutions do not
    exist, obviously the rate of return has to be higher to attract
    the capital to reflect the added risk that is involved. I think
    one of the benefits of these kinds of free trade agreements is
    that they open up markets more to promote more capital flows
    back and forth from country to country, and more flows of goods
    and services, which of course the financing is accompanying.
    That is why the capital flows are going back and forth as well.
        So these agreements actually are a good start, which help
    other countries to see what they need to do to attract capital.
    They see the results from the standpoint of the marketplace and
    the rate of their own development, which is a very powerful
    incentive for them to open up and to create these institutions.
        Mr. Feeney. Thank you.
        Mr. Tarullo?
        Mr. Tarullo. Thank you, Mr. Chairman.
        Mr. Chairman, I will end where I began, which is urging
    some sense of modesty in this area. We are all experts in
    retrospect. We look back at the Asia financial crisis, and we
    say, aha, that is what happened. But if we are honest with
    ourselves and go back eight or ten years, so far as I am aware
    the people at this table and the people elsewhere were not
    identifying some of the problems which we now in retrospect see
    were very important. I have no doubt but that the next
    financial crisis, when it comes, will contain elements of
    traditional financial vulnerabilities and will contain
    something new, that will be a surprise, and that will give more
    fodder for scholarly and policy work thereafter.
        I think the reason why some of us are concerned with the
    capital controls provisions is not because we want to go
    proselytizing for capital controls. I think Dr. Bhagwati and I
    have tried to make that clear in our own approaches to this
    issue. We believe we need to understand this more, we need to
    understand where and how problems may arise, and we need to
    have a system prepared that will allow countries to respond if
    the worst happens. My own sense is that if Singapore and Chile
    are concerned about not having this fallback position, then
    other countries with even less well-developed capital markets
    and regulatory systems are even less well developed, will be
    more concerned. I do not think we want to push them down that
    road. I think what we want to help them to do is to build the
    institutions that will make for strong securities markets and
    strong bank regulatory systems, and then see what benefits the
    free flows of capital can bring.
        Thank you very much.
        Mr. Feeney. Thank you.
        And finally, Mr. Vastine, you can sum up.
        Mr. Vastine. Thank you very much, Mr. Chairman.
        First of all, these are good agreements. They contain a
    great deal more than the capital issues. Congress should adopt
    these agreements. Chile and Singapore freely agreed to these
    provisions. I was familiar with these negotiations. No one held
    a gun to their heads. They are very sophisticated negotiators.
    They are very good regulators.
        Finally, I do not think the objections raised today give
    grounds to the committee or to other members of Congress not to
    vote for these agreements.
        Thank you.
        Mr. Feeney. I want to thank all of you. We will get you out
    for a late lunch. The chair would like to thank all of you for
    traveling and being here with us today. Without objection, the
    record of today's hearing will remain open for 30 days to
    receive additional material from members and supplementary
    written responses from witnesses to any question posed by a
    member on the panel.
        The hearing of the Domestic and International Monetary
    Policy Subcommittee is hereby adjourned.
        [Whereupon, at 12:35 p.m., the subcommittee was adjourned.]

                                A P P E N D I X

                                 April 1, 2003

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