Retreat from globalization

Nothing is more usual, among states which have made some advances in commerce, than to look on the progress of their neighbours with a suspicious eye, to consider all trading states as their rivals, and to suppose that it is impossible for any of them to flourish, but at their expence.

--David Hume, Of the Jealousy of Trade

THESE are days of optimism about U.S. and world economic prospects. The U.S. economy is poised for strong recovery, most Wall Street economists say. The optimism seems as misplaced as it was in 1999 when the U.S. economy was generally described in miraculous terms yet was on the verge of downturn and two years short of outright recession.

In many regards, the U.S. economic picture now looks far worse than it did in 1999. In 1999 there was a stock bubble that Federal Reserve Chairman Alan Greenspan had, it appeared, inadvertently allowed to build. Four years on, resorting actively to unsustainable bubbles in asset prices has become the mainstay of U.S. policymaking. What Greenspan refers to as "solid gains" in housing prices are no more than a bubble in the prices of households' most important financial asset.

Cheap money has also helped to re-inflate stock prices. Meanwhile, the Bush Administration's fiscal policy, which floods the American consumer with windfall cash, seems just as unsustainable. The counterpart of these policies is the precipitous fall of the dollar.

All the mistakes are part of a general loss of direction in economic policymaking, an abandonment of ideas of sound money and honest reward. The United States is now pursuing a new goal in policymaking: the permanent consumer boom, instant wealth created by windfall. Perhaps this is a true measure of America's decline: immediate gratification has become not just the vice of the couch potato but that of Washington, DC.

This makes a mockery of American attempts to advise other countries on economic policy. The "Washington Consensus" emphasized sound fiscal and monetary policy, privatization and faith in free markets. It is dead because Washington has abandoned these policies. This will harm not only the U.S. economy but the world one as well. The world no longer has a leader in economic policymaking. Nowhere is that lack of leadership more evident than in trade.

The failure of the ministerial summit meeting of the World Trade Organization (WTO) in Cancun, Mexico in September was prepared by the prior positions adopted by the main players: the United States, the European Union and developing countries. The positions of all were characterized by hypocrisy. Perhaps the greatest hypocrisy, however, was that of the United States, which preaches the merits of free trade more strongly than almost any other country and yet spends tens of billions of dollars to prevent its own markets from being free and has taken fresh measures in recent years to discriminate against other countries' producers.

The biggest blow to the Doha Round was struck in 2002 when a new farm bill was passed by the U.S. Congress. The new bill authorized, in the words of the U.S. trade representative, Robert Zoellick, "up to $123 billion in all types of food-stamp, conservation and farm spending over six years."

The U.S. position--and that of the EU--is immoral. Developing countries that depend utterly on agriculture are forced to compete with a U.S. agricultural sector that is hugely subsidized. Yet the United States constantly urges countries to open their own markets and allow freer access to U.S. goods and services. The blatant hypocrisy is doing nothing to win the United States friends and allies and is therefore a political problem as well as an economic one. And there are many other problems with it. The subsidies for the agricultural sector add to the U.S. budget deficit. The protection granted to U.S. producers means consumers pay higher prices. Poor countries that might earn more in exports and therefore be able to import more from the United States remain impoverished--to their detriment and to that of the United States and other countries.

Those who fail to appreciate what harm this is doing might have done well to attend a small meeting of west African cotton producers at the WTO Cancun summit, shortly before the meeting's collapse, in which these producers reacted to the draft text that had then been drawn up. It was hard to judge which was greater: their sense of betrayal or their anger.

One of the delegates pointed out that the cotton farmers he represented earn less than $1 per day; and that, internationally, the argument that these farmers were producing competitively and were the victims of subsidies and restriction of trade in the developed world had been well accepted. And yet, in the view of these delegates, there was nothing in the text to encourage them, no sign that the developed world was ready to give ground. The unhappiness culminated in this lament from a delegate from Senegal: "What is the point of us Africans coming to summits such as this when nothing is going to be done?"

This was an indictment of the hypocrisy of the developed countries, a condemnation of what David Hume called "narrow and malignant policies" which, were they to meet with success,

   should reduce all our neighbouring nations to
   the same state of sloth and ignorance that prevails
   in Morocco and the coast of Barbary. But
   what would be the consequence? They could
   send us no commodities: They could take
   none from us.

Two and a half centuries after Hume's essay, how is it possible that the lessons have not been learned; that the agricultural exports of countries such as Senegal and Mall and Togo, or Bangladesh or Brazil, and countless other poor countries, are blocked from world markets so that these countries fail to thrive and can therefore import little from the developed world?

What the United States and the European Union bring to trade meetings at present is not a willingness to do what is right but a determination not to give anything away. The tactic on which the big countries rely is brinkmanship. Gather the countries together, put forward a mean negotiating position, see which countries are most opposed, work individually on countries whose opposition might readily be worn down by a favor here or a favor there; make concessions, as small as possible; bully; use the weight of economic size and geopolitical clout; get a signature on a piece of paper that the developing country will eventually have cause to regret.

In Cancun this approach failed in part because developing countries have become more and more aware of the hypocrisy of the United States and the European Union. They realize that subsidized agriculture in developed countries is now the biggest obstacle to free trade. In addition, they have learned bitter lessons from experience. They have made agreements in the past and been deceived. For example, as part of the Uruguay Round of trade negotiations, completed in 1994, the United States committed itself to opening up its textile sector. But, according to Daniel Ikenson, an expert in trade at the Cato Institute, "80 percent of the products subject to quota in 1994 still are." Tricks, legal maneuvers, and the letter of manipulated laws have been used against developing countries, embittering America's relations with the developing world.

This is not to say that the United States is entirely to blame for the failure of world trade talks. The European Union and the developing countries are also hypocritical. Average tariffs in developing countries are very high; averaging about 30 percent in India, for example, compared with less than 5 percent in developed countries and Indian industry is heavily protected. Indian consumers pay the price. Predictably, Indian industry fails to become competitive enough to export. Moreover, the tariff barriers apply between developing countries as well and help to keep markets small and segmented, strangling the growth of larger, internationally competitive companies.

In Europe, meanwhile, we might see President Jacques Chirac of France as Bush's twin. In late 2002 Chirac persuaded Germany to agree to defer until 2013 any meaningful attempt to reduce the subsidies paid under the European Union's Common Agricultural Policy (CAP). In June 2003 a modest reform was undertaken to de-link subsidies from production (this might help to curb EU overproduction). But overall subsidy levels were not cut; nor were export subsidies reduced. The CAP has a direct annual cost to EU taxpayers of some $40 billion and an indirect cost via higher prices for food that is several times greater. It serves to redirect European taxpayers' money to the agricultural industry while depriving developing countries of a market. The CAP is an obscenity. The United States uses it as an excuse to preserve an obscenity of its own: "America will not cut agricultural support unilaterally. But America's farmers and Congress back our proposal that all nations should cut together", wrote Zoellick, in an article in The Economist in December 2002.

The U.S. position on major reform of trade might therefore be described as "after you, Europe." It doesn't say much for Bush's capacity to lead. Yet to picture things in this way would be charitable. Bush has not just failed to lead. He has actively damaged the prospects for world trade and growth.

The New Protectionism

Where a great number of commodities are raised and perfected for the home-market, there will always be found some which can be exported with advantage. But if our neighbours have no art or cultivation, they cannot take them; because they will have nothing to give in exchange.

--David Hume, Of the Jealousy of Trade

BUSH'S FAILURES would seem to be harbingers of a new and deeply troubling protectionism in the United States that evokes the mood of the 1930s. In part it comes from the top, from Bush's desire to win votes from steel workers and farmers. But it also comes from below: from workers who are nervous about their jobs and their financial security and from corporations who fear their ability to compete with emerging nations, especially China.

Companies always fear competition. Few company executives are advocates of free trade. They are in the competitive game and, like soccer players, always call on the referee to adjudicate in their favor, however dubious their claim. Workers, for their part, are always anxious to retain their jobs and cannot be expected to see the broader picture. This is why strong and honest leadership is needed. Leaders must see above the fray, the bitter complaints of interest groups and of those who lose out in the battle to compete, and keep their eyes fixed on the greater global good that can be achieved by freer trade.

It is sad that the Bush Administration has not proven principled and upright. Yet its Democratic opponents show every sign of embracing still more wholeheartedly the popular mood of protectionism. Protectionist sentiment has struck a chord among voters and is likely to play a role in the Democrats' election strategy. Even as candidates drop out of the race, their ideas continue to have an impact on the formulation of an electoral agenda.

For example, tapping into popular resentment at inexpensive imports, particularly textiles from China, Democrat candidates for president have castigated the Bush Administration for doing too little, too late to stem the flow. Yet the protectionist approach, while tailored to please American textile workers, is full of hypocrisy. Textiles are relatively simple to design and to manufacture, and thus developing countries can produce them competitively. And, as we have seen, the United States has remained protectionist in the textile sector despite committing more than a decade ago to open its market. It is, in short, neither China nor developing countries that have reneged on agreements and played a dirty game, but the world's biggest economy.

The presumptive nominee, Massachusetts Senator John Kerry, notes that if elected, he would order

   an immediate 120 day review of all existing
   trade agreements to ensure that our trade
   partners are living up to their labor and environment
   obligations and that trade agreements
   are enforceable and are balanced for
   America's workers.

Kerry says he "will consider necessary steps if they are not."

Kerry takes the position that "Some nations have consistently violated agreements by the World Trade Organization." Governor Howard Dean espouses a similar line. The United States, it seems, is being deceived by other countries:

   Stemming job losses means vigorously enforcing
   the terms of existing trade agreements.
   The Bush Administration ... has only brought
   eight trade cases before the WTO, while the
   Clinton Administration filed twenty-seven
   WTO actions in its last three years in office.
   Moreover, the Administration has lost fourteen
   of the sixteen WTO cases it has defended.
   This track record means lost American jobs
   and lost business opportunities.... [W]e need
   an Administration that will stand up for
   American trade laws.

These recommendations would temporarily save some jobs in uncompetitive firms--at a cost to U.S. consumers and to the detriment of workers overseas--but otherwise assure the prosperity only of some Washington legal firms.

Job losses also come under fire. "The Bush Administration has done nothing to end incentives that encourage manufacturers to move their jobs overseas", Kerry proclaims. He promises that "we should not only get rid of these incentives, but that we should give new tax breaks to companies that stay in the U.S. and create new jobs." In addition, firms that move jobs overseas "should not get government contracts or any other perks or incentives from the government." Senator John Edwards asserts still more strongly that jobs are being stolen from Americans by foreigners while Bush sleeps:

   Under George Bush, America has lost more
   than 3 million private sector jobs, and 1
   million jobs have been lost overseas. Not
   only are we losing jobs; we are losing highpaying
   jobs. Outsourcing has affected
   everyone from call center workers to computer
   programmers.

What is interesting about this position is that it goes beyond what might be called traditional protectionism: the "give me a tariff barrier, or a quota or a legal restriction" that might be called sufficient for all normal purposes. This attack is essentially on businesses themselves, on their decision to think globally and employ overseas workers rather than American ones.

Should politicians be standing in the way of that sort of decision? Are company executives not free to decide how best to deploy resources around the world in order to compete and be successful? Does America not believe in globalization?

The next level of protectionism involves tying the hands of foreign competitors with red tape. It finds its most extreme expression in the suggestion by a Democrat who, perhaps fortunately, dropped out of the running for the presidential candidacy--Richard Gephardt. His idea is an international minimum wage. To find the right level for a minimum wage in any one country is, of course, challenging; and there is a question mark about whether a minimum wage is a useful guideline at all. But to apply one internationally would be technically and bureaucratically impossible and useful only for one thing: finding grounds on which to block exports to the United States. The proposal, put forward as being principled and oriented to improving workers' remuneration around the world, is at root utterly cynical, an attempt to save jobs here while denying them to workers overseas.

Finally, Kerry tackles the question of exchange rates:

   China, Japan and other nations have purposely
   kept their currency undervalued relative to the
   U.S. dollar to promote exports in the United
   States and undermine U.S. products abroad.

This accusation of deliberately maintaining a weak currency in order to gain a competitive advantage has been frequently made against China in the past year. But in fact the case is difficult to make. The dollar has, of course, plummeted against the euro in the past year and has weakened against the Japanese yen. Asian countries certainly do not want their currencies to appreciate against the dollar and China maintains a fixed rate. But one of the means Japan and other Asian countries have employed to prevent currency appreciation against the dollar has been to buy U.S. government debt.

According to recent U.S. Treasury data, between January and November 2003, foreign holdings of U.S. Treasuries rose by $264 billion. Japan, the major foreign holder of U.S. government debt, increased its holdings by $135 billion (to a total holding in November 2003 of $525.5 billion.) The second largest holder is China, which increased its holdings of Treasury debt by $23.1 billion to $143.8 billion. (By way of comparison, the United Kingdom is the third largest foreign holder, at $111.7 billion.)

Buying U.S. debt in this way helps to recycle bilateral trade surpluses with the United States and helps to prevent further appreciation of the yen against the dollar. But can Japan be blamed by U.S. politicians for buying U.S. government debt and, in effect, financing about half of Bush's huge budget deficit in the past year?

Where China is concerned, what must be taken into account is that Chinese export companies aim to undercut their competitors and do have some flexibility on price. Appreciation of the renminbi might do little to harm their price competitiveness. Moreover, Federal Reserve Chairman Alan Greenspan and others have rightly remarked that if the Chinese currency is being kept undervalued through an accumulation of reserves, then such undervaluation is creating too rapid credit growth. Then the greatest harm done by currency policy will be not to China's competitors but to the Chinese economy.

Above all, what is lacking in the current U.S. view of international trade is a sense of the gains from trade that David Hume laid out so brilliantly 250 years ago. The Chinese economy is one of the few in the world to show strong growth. China exports, but it also has a dynamism of its own, born of the free market reforms initiated by Deng Xiaoping in 1978. A once-communist economy is finding fresh life as free enterprise flows through its veins. This is something in which the United States should rejoice, not lament. For it is certainly true that the America's macroeconomic weaknesses have been exacerbated by the lack of growth in Europe and Japan in recent years. If the European and Japanese economies were more dynamic, U.S. exports would be higher and so would U.S. growth, and the U.S. trade and current account deficits would be lower, thereby reducing the need for foreign capital inflows.

The U.S. economy cannot grow fast alone. The prosperity of other countries brings prosperity to the United States. That, no doubt, is one reason why Washington has for so long recommended that foreign countries open their markets.

Bubble Economy and Unwise Policy

ALL THE above may lead to some questions. Why is the United States losing jobs if unfair trade is not the reason? What has gone wrong? What does the United States need to do to regain a truly thriving economy?

My argument, stated briefly, is as follows. The United States has enjoyed, since the mid-1990s, a period of generally high growth. In the late 1990s the U.S. economy (and, in consequence, the world's) was distorted by inflation in stock prices and the wealth effect that generated. The American "economic miracle" was a stock bubble that fostered high spending, high growth, high inflows of foreign investment (drawn to the miracle economy) and a consumer boom.

After the false boom promoted by stock price inflation, the natural tendency of the economy has been to feel deflationary forces. That tendency, though painful, was salutary. Very low rates of saving, with the counterpart of a very high trade deficit, had to be corrected. But both Bush and Greenspan have fought to prevent this rebalancing--and have succeeded temporarily. Now a huge budget deficit joins the trade deficit while house-price inflation emulates the stock market bubble of the late 1990s.

As the Democrat presidential candidates reiterate, unemployment has risen by close to three million in the United States under President Bush. But this rise cannot be blamed on Bush. On the contrary, if he and Greenspan had not stimulated consumption by pursuing such expansionary policies, the rise would have been much greater. The U.S. trade deficit continues to be evidence not of an economy that is growing too slowly, but one that requires a correction greater than can be provided by the falling dollar.

The United States has been living beyond its means, saving little, consuming generously. The brief and shallow recession of 2001 was insufficient to provide a correction. The cyclical correction will come. This is the macroeconomic side to the U.S. economy's difficulties.

But there are also microeconomic aspects in the difficulties of the U.S. economy. In the boom years greed prospered. A part of the American tradition of hard, honest work may have given way to another American tradition: carpetbagging.

In the boom years, too, other excesses may have prospered. Government spending at federal, state and municipal levels has not been curbed. And many costs that fall upon government, companies and individuals have not been restrained. Witness, for example, the inexorable and rapid rise in costs for health care and health insurance. All these factors are affecting America's competitiveness.

Perhaps former candidate Edwards is more on track, seeing what is wrong with the American economy when he says this about education:

   American high school students are almost
   last in the world in math and science. In
   addition, each year, Chinese universities
   graduate five times more engineers than do
   American universities.

Health costs, corruption in business, poor (and often expensive) education: these are the problems on which American government should be focusing if the United States wishes to thrive. But instead, the Bush Administration has resorted to a protectionism that Democrat presidential candidates threaten to deepen, putting forward manufacturing tax credits, or tax rebates for state governments as means to achieve prosperity. Where is the faith in honest endeavor for honest reward?

Lean government, free trade, excellent education: it is telling that U.S. politicians are working against the first two while doing little to promote the third. At a time when the macroeconomy has been harmed by a stock market bubble, the United States needs to be clear about policies that yield economic success. Instead it seems drawn to wild fiscal and monetary policies and to protectionism. America has lost its way.

A Comforting Qualification

The present moment is one of great distress. But how small will that distress appear when we think over the history of the last forty years; a war, compared with which all other wars sink into insignificance; taxation, such as the most heavily taxed people of former times could not have conceived; a debt larger than all the public debts that ever existed in the world added together; the food of the people studiously rendered dear; the currency imprudently debased, and imprudently restored. Yet is the country poorer than in 1790? We firmly believe that, in spite of all the misgovernment of her rulers, she has been almost constantly becoming richer and richer. Now and then there has been a stoppage; now and then a short retrogression; but as to the general tendency there can be no doubt. A single breaker may recede; but the tide is evidently coming in.

--Thomas Babington Macaulay, Review of "Southey's Colloquies on Society", 1830.

Ian Campbell, formerly the Chief Economist for Emerging Markets at ABN AMRO Bank and Director of Latin American Research at Bank Boston, is a writer and economist.

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