Buy Globally? The Economist Steps Up
Saturday, February 7, 2009 at 03:04PM Actually my good friend Veronica Preotu beats me to it , but since I think it is important I believe an additional shout is in order. It has been a couple of months since I let my subscription lapse on the Economist, for no particularly reason really. I simply did not remember to log on to their site and fork over the cash and since I was in Switzerland at the time I did not bother to re-subscribe. It can take quite a while to change address with the publishers. However, perhaps I should consider whether I should re-commence the weekly delivery of the print edition.
It is of course not coincidental that the Economist with its history and background reacts strongly to the growing number of voices, more or less explicitly, calling for protectionism to fight off the different national recessions. The Economist as a magazine was in many ways defined around the idea that liberal access to global factor markets of all nations is the right path to prosperity.
In the current discourse, the debate and problems have naturally changed. Yet, arguments in favor of protectionism to ward of recessions are still build on nonsensical arguments; this recession is global and thus we must act globally to counteract it. More specifically, the free flow of goods, services, and capital is chief in whatever recovery we want to engineer. Naturally, even in the face of strong objective arguments bad arguments and decisions may still be forcefully delivered and taken.
Veronica calls the Economist's position opinion makings from the right and she may be of course be on to something here. I have not followed the ideological skirmishes that much in the past months to know whether we are about to have an ideological battle, but I would hope however that the ability to see the detrimental effects of economic nationalism would transcend most, self-proclaimed, ideological economic camps. I may of course be wrong.
In their leader, and a longer briefing piece, the Economist rightfully points towards the most concerning messages emanating from the US congress' discussion about the projected 800 bn stimulus package. We have even heard scant chattering about the ominous parole "buy American" which of course can be translated into many languages to counter any initial move. The Economist is right to put the new president elect in the spotlight. For all the positive signals and reiterations of we can, one nagging feeling many have had with the incoming Obama administration was always whether it would be prone to knee jerk protectionist measures when the goings got tough. President Obama now has a golden opportunity to finally lay this to rest and he should do so, with great force. The Economist also aptly points to the fact that despite governments' claims to the contrary protectionist measures have a tendency to be anything but temporary once instigated. The laws passed under the Great Depression on the basis of the work by Reed Smoot and Willis Hawley represent an important case in point [1].
Below, I reproduce the full leader which I fully endorse;
MANAGING a crisis as complex as this one has so far called for nuance and pragmatism rather than stridency and principle. Should governments prop up credit markets by offering guarantees or creating bad banks? Probably both. What package of fiscal stimulus would be most effective? It varies from one country to the next. Should banks be nationalised? Yes, in some circumstances. Only the foolish and the partisan have rejected (or embraced) any solutions categorically.
But the re-emergence of a spectre from the darkest period of modern history argues for a different, indeed strident, response. Economic nationalism—the urge to keep jobs and capital at home—is both turning the economic crisis into a political one and threatening the world with depression. If it is not buried again forthwith, the consequences will be dire.
Devil take the hindmost
Trade encourages specialisation, which brings prosperity; global capital markets, for all their problems, allocate money more efficiently than local ones; economic co-operation encourages confidence and enhances security. Yet despite its obvious benefits, the globalised economy is under threat.
Congress is arguing about a clause in the $800 billion-plus stimulus package that in its most extreme form would press for the use of American materials in public works. Earlier, Tim Geithner, the new treasury secretary, accused China of “manipulating” its currency, prompting snarls from Beijing. Around the world, carmakers have lobbied for support (see article), and some have got it. A host of industries, in countries from India to Ecuador, want help from their governments.
The grip of nationalism is tightest in banking (see article). In France and Britain, politicians pouring taxpayers’ money into ailing banks are demanding that the cash be lent at home. Since banks are reducing overall lending, that means repatriating cash. Regulators are thinking nationally too. Switzerland now favours domestic loans by ignoring them in one measure of the capital its banks need to hold; foreign loans count in full.
Governments protect goods and capital largely in order to protect jobs. Around the world, workers are demanding help from the state with increasing panic. British strikers, quoting Gordon Brown’s ill-chosen words back at him, are demanding that he provide “British jobs for British workers” (see article). In France more than 1m people stayed away from work on January 29th, marching for jobs and wages. In Greece police used tear gas to control farmers calling for even more subsidies.
Three arguments are raised in defence of economic nationalism: that it is justified commercially; that it is justified politically; and that it won’t get very far. On the first point, some damaged banks may feel safer retreating to their home markets, where they understand the risks and benefit from scale; but that is a trend which governments should seek to counteract, not to encourage. On the second point, it is reasonable for politicians to want to spend taxpayers’ money at home—so long as the costs of doing so are not unacceptably high.
In this case, however, the costs could be enormous. For the third argument—that protectionism will not get very far—is dangerously complacent. True, everybody sensible scoffs at Reed Smoot and Willis Hawley, the lawmakers who in 1930 exacerbated the Depression by raising American tariffs. But reasonable people opposed them at the time, and failed to stop them: 1,028 economists petitioned against their bill. Certainly, global supply-chains are more complex and harder to pick apart than in those days. But when nationalism is on the march, even commercial logic gets trampled underfoot.
The links that bind countries’ economies together are under strain. World trade may well shrink this year for the first time since 1982. Net private-sector capital flows to the emerging markets are likely to fall to $165 billion, from a peak of $929 billion in 2007. Even if there were no policies to undermine it, globalisation is suffering its biggest reversal in the modern era.
Politicians know that, with support for open markets low and falling, they must be seen to do something; and policies designed to put something right at home can inadvertently eat away at the global system. An attempt to prop up Ireland’s banks last year sucked deposits out of Britain’s. American plans to monitor domestic bank lending month by month will encourage lending at home rather than abroad. As countries try to save themselves they endanger each other.
The big question is what America will do. At some moments in this crisis it has shown the way—by agreeing to supply dollars to countries that needed them, and by guaranteeing the contracts of European banks when it rescued a big insurer. But the “Buy American” provisions in the stimulus bill are alarmingly nationalistic. They would not even boost American employment in the short run, because—just as with Smoot-Hawley—the inevitable retaliation would destroy more jobs at exporting firms. And the political consequences would be far worse than the economic ones. They would send a disastrous signal to the rest of the world: the champion of open markets is going it alone.
A time to act
Barack Obama says that he doesn’t like “Buy American” (and the provisions have been softened in the Senate’s version of the stimulus plan). That’s good—but not enough. Mr Obama should veto the entire package unless they are removed. And he must go further, by championing three principles.
The first principle is co-ordination—especially in rescue packages, like the one that helped the rich world’s banks last year. Countries’ stimulus plans should be built around common principles, even if they differ in the details. Co-ordination is good economics, as well as good politics: combined plans are also more economically potent than national ones.
The second principle is forbearance. Each nation’s stimulus plan should embrace open markets, even if some foreigners will benefit. Similarly, financial regulators should leave the re-regulation of cross-border banking until later, at an international level, rather than beggaring their neighbours by grabbing scarce capital, setting targets for domestic lending and drawing up rules with long-term consequences now.
The third principle is multilateralism. The IMF and the development banks should help to meet emerging markets’ shortfall in capital. They need the structure and the resources to do so. The World Trade Organisation can help to shore up the trading system if its members pledge to complete the Doha round of trade talks and make good on their promise at last year’s G20 meeting to put aside the arsenal of trade sanctions.
When economic conflict seems more likely than ever, what can persuade countries to give up their trade weapons? American leadership is the only chance. The international economic system depends upon a guarantor, prepared to back it during crises. In the 19th century Britain played that part. Nobody did between the wars, and the consequences were disastrous. Partly because of that mistake, America bravely sponsored a new economic order after the second world war.
Once again, the task of saving the world economy falls to America. Mr Obama must show that he is ready for it. If he is, he should kill any “Buy American” provisions. If he isn’t, America and the rest of the world are in deep trouble.
[1] - If you want an in depth account of the Smoot-Hawley act, the Economist had a very good article about it in their Christmas bumper edition.
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Reader Comments (4)
i'm happy you keep track on my "wonders". you know, before i was thinking that a good argument is a good argument (of course) and thus it could convince me. anyway, these days each economist is more or less to the right or to the left. in fact, a lot of them state clearly: "you know, i graduated at cambridge, beware i'm keen on keynes and i sustain the government in the economy" or "whatever happens, i'm a chicago boy, i know there's a need for a stimulus, but not too much, please!". of course, the truth is somewhere in between. and it's good they state from the beginning if they love or not the government. anyway, i decided to consider less who is right but more what is to be learned from all this crisis.
as for the economic nationalism, i've just read krugman's opinion - http://krugman.blogs.nytimes.com/2009/02/01/protectionism-and-stimulus-wonkish/ and i see "short-run protectionism" and thus this time component comes again in discussion. but what is short-run? and back to the "impossibility of economists to predict", "black swans" and so on...
Nationalism and protectionism should not be confused. The link made between them serves the purpose of mutening the debate on protectionism.
What should be done is investigate whether the benefits of international comparitive advantages through specialization really exist and consequently why in some cases protectionism led to an ugly outcome.
History shows that mutual advantages through specialisation do not really exist at least not in the long term and not in an objective sense, and that supposed free trade creates imbalances that are themselves the root of the ugly outcome that is contributed to protectionism. Most confuse symptoms and causes.
The core issue is that in an ideal world where every country plays the game of free trade by the rules, it works, but that world never existed and will never exist. And it's easy to recognize the cheaters and benefitors of the game for they shout the loudest to keep "free" trade in this non-utopian world.
Perhaps it is me who is falling victim to some kneejerk ideologism here, but I do feel quite strongly about the point so ...
I was struck by this from Veronica ...
" (...) of course, the truth is somewhere in between"
Clearly this is true in so far as goes the general picture, but sometimes one side just HAS the right arguments. For example, there is a lot of quibble at the moment about fiscal spending v tax cuts (since everybody seem to agree that action is warranted); now normally I would be on the tax cut side since ultimately I am a liberal/rightish (European scale) although this might of course make me a liberal/leftish on the US scale *headache* ...
Anyway ...
I am quite convinced that all the money going to the economy in the form of tax cuts will be saved. I mean, call ricardian equivalence or call it precautionary saving; I really don't care, but when people are losing their jobs with the current magnitude it is not difficult to see how they would use any windfall. On this note I am 100% with Krugman since I think he has it right on THIS point. This is where I feel that all that silly saltwater v freshwater economics bla bla is so detrimental since for crying out loud why can't the other side just admit the obvious. Then, they can have the "big government discussion" later; we are in a crisis you know!
Now, about Krugman's other point I simply disagree since I think that while the liquidity trap argument may have a lot of validity, also globally, we need openess to correct the imbalances building up; otherwise those country who cannot fuel growth on their own will see their economies fall apart. Somebody needs to face the music and do the importing.
"What should be done is investigate whether the benefits of international comparitive advantages through specialization really exist and consequently why in some cases protectionism led to an ugly outcome."
Yes, of course and I admit that blind faith in comparative advantage is every bit as stupid as the opposing position.
"The core issue is that in an ideal world where every country plays the game of free trade by the rules, it works, but that world never existed and will never exist. And it's easy to recognize the cheaters and benefitors of the game for they shout the loudest to keep "free" trade in this non-utopian world."
Again, agreed Geert, but the US has a responsibility pure and simply for raising the bar in this game and while this may seem equally as utopian there is also a strong political message to be sent here.
Having said though, if the US economy is as screwed as it seems, then so be it ... I mean, slam on the protectionist brakes and as the USD falls you can only hope that all those bond issues may be financed by domestic saving (which is not entirely impossible I think); I mean this is how Japan got from here to there (160% debt to GDP).BUT, I would rather that they tried to avoid this situation.
So, it seems as if we are down to this ...
Krugman:
"Let’s be clear: this isn’t an argument for beggaring thy neighbor, it’s an argument that protectionism can make the world as a whole better off. It’s a second-best argument — coordinated policy is the first-best answer. But it needs to be taken seriously."
Ok, but what world is he talking about here really? I think it would be better to identify the underlying causes/drivers of global capital flows and then try to induce a way to allocate the flows in a way which is sustainable.
Finally Geert ...
"History shows that mutual advantages through specialisation do not really exist at least not in the long term and not in an objective sense, and that supposed free trade creates imbalances that are themselves the root of the ugly outcome that is contributed to protectionism. Most confuse symptoms and causes."
Well put ... but I would still argue that the road from "a to b" and thus the ability of nations to choose between consumption and saving is a natural function of openess and that this mutual intertemporal substition is beneficial; the problem is of course when everybody has the same preference for one over the other as well as the current situation when the incentive to "use" other countries' fiscal stimulus is high
Claus
I'd like to give one more comment to clarify a bit my position.
We're not really in disagreement but there's a kind of time mismatch.
Moderate protectionism is a useful tool to prevent imbalances. When one country tries to achieve an advantage by using protectionism it must be answered right away (*). Or when a country threatens to loose its economic independency, it must act to protect itself (just like every "Darwinian" individual will do).
Once they let those imbalances come in place, protectionism as a mean to correct them, worsens the situation and instead of a recession it offers us a depression (for all sides).
What economists/humans remember is that protectionism hasn't offered a solution and is thefore "bad" and must be avoided by all means in the future whatever the circumstances. However as bad times passed, imbalances have been removed and then is the time to prevent them from coming back. Unfortunately we're indoctrinated by the latest experience.
Protectionism is not a cure, it is moderation to avoid getting sick.
Of course this is only part of the story. I know the US consumer has been on a spending spree but that is typical for our society where consumption has become a function of price instead of a function of our needs. How long have we been worshipping "price" as the statue of Nebukadnezar now?
Something that leads me to prefer fiscal spending over tax cuts, but that would become too long a story.
best
geert
(*) On Ricardo: Portugal remained an underdeveloped country while the UK experienced an economic boom; and why, because the UK introduced a series of protectionist laws; no wonder Ricardo paid lipservice to free trade. Maybe his opinion was just the expression of patriotism :) No, serious, when we benefit we think it is good and it is free trade and just.
(**) my "belief" results from the broad concept that nothing is inherently bad or good, it only suits or doesn't suit the environment of the moment (if memory serves, Edward gave a good example lately on the concept of "low interest rates")