A Reminder, Revisited

(Our look back at 2009 is stretching out into January a little, but I'm not quite finished with the stock-taking exercise. Our soap box, our rules)

Around this time last year, I pointed out that, if nothing else, 2008 drove home a fundamental lesson of IPE: the economy drives politics. Many of the best laid plans of early 2008 were sucked down the toilet along with the global economy, leading to some surprising outcomes.

My question for 2009 was therefore: how hard would politics push back? Because push back it did: countries that once championed free market principles quickly turned inward in order to protect their interests and respond to popular outrage. Let's have a look back:

Protectionism

As discussed below, the spectre of protectionism was haunting us early in 2009. In Britain, we suddenly saw shades of populist xenophobia from Gordon Brown (pray tell us, Gord, what exactly constitutes a British worker? shall we ask the BNP?). In the USA there was the noxious "Buy American" clause, the auto-bailout, and some other hilarious examples. India banned Chinese toys for six months. But the most gregarious example of all comes from China itself: the undervaluation of the yuan, and its consequences for everyone else, is probably the biggest protectionist story of the year.

Tobin Tax
While not exactly a crackpot policy proposal, the Tobin Tax (explained here) is still a bad idea. Unfortunately, because it was re-introduced by Lord Turner of the FSA in a widely-publicized report, it got a lot of media play. Thankfully, the US made it clear that they weren't interested so the idea was stillborn (er, maybe not).

[Don't get me wrong - sometimes capital controls are a good idea, especially for emerging markets facing massive inflows of capital, but more on that later.]

Pay czars! Wait, Pay czars?

Somehow the use of the term "czar" here just doesn't inspire confidence. Here we have liberal, democratic, relatively free and competitive societies appointing pay czars to set limits on the compensation of a particular subset of society. I get that skewed pay incentives led to excessive risk-taking, but there were much bigger factors at play.

However, as one astute observer pointed out, the job description of the pay czar is not to curb bankers' pay but rather to curb public anger at bankers' pay. I hope it worked, since I'll bet there were some Frenchmen dusting off their guillotines... just in case.

SuperTax 2009

Further caving to popular anger, the UK and France introduced the SuperTax 2009. I feel no sympathy for the uber-rich bankers traveling in their Mercedes to the Human Rights Tribunal to plead their case. But why stop at bankers? You should at least be consistent.

We Still Like Capitalism, Though, Right?

Taking the long view, capitalism has been a resounding success for humanity. It is the single biggest poverty-killer in history. But as we have seen, the free market is a fragile thing, and prone to excesses. These excesses produce backlash, and the backlash can be severe.

We need only ask John Maynard Keynes, a first-hand observer of how bad the backlash can be. An astute observer of history and human psychology, Keynes had the following to say about pre-WWI Europe:

The power to become habituated to his surroundings is a marked characteristic of mankind. Very few of us realize with conviction the intensely unusual, unstable, complicated, unreliable, temporary nature of the economic organization by which Western Europe has lived for the last half century. We assume some of the most peculiar and temporary of our late advantages as natural, permanent, and to be depended on, and we lay our plans accordingly.

Those advantages collapsed spectacularly in 1914. We spent the next seven decades sorting out the mess. Now, I'm not suggesting that pay czars and supertaxes are the first steps towards a return to communism or fascism or whatever - not by a long shot. But try to remember how unlikely those things would have seemed a couple of years ago. Things change in a hurry.

The lesson that I take from all of this is as follows: the liberal market economy is a fragile social experiment - it is not a naturally occurring phenomenon. We need to keep this message in the back of our minds as we take stock of recent events. This little project of ours requires safeguarding, not hysterics. So let's tone down the ideology and tone down the populism and instead focus on pragmatic ways to keep it going a little longer.

Monday Morning Round-Up

Awesome blogs by "really smart people" (pointer from Free Exchange)

The Buy-American mentality in action: a Belgian-owned, Canadian-made pipe is ripped out of the ground and replaced by an identical one that was made in the U.S. of A. Serves 'em right for making bilingual pipes, anyway.

The podcast of a CFR round-table entitled "The Financial Crisis and Global Financial and Monetary Cooperation"

Boeing's arial drones are now available for rent.

Taking stock at Arsenal

The summer of our discontent

Millions of protesters took to the streets across France yesterday to protest what is loosely being described as the "economic policies" of French president Nicolas Sarkozy. I know, saying the French are taking to the streets is like saying the sun always rises. Obvious.

However, the protests are but the most immediate example of widespread and growing popular discontent with the financial crisis and the response of governments. Governments in Iceland, Belgium and Latvia have already fallen, and political instability is rising across Eastern Europe, Africa and Asia in response to food shortages, budget cuts and rising unemployment. Even in Russia, the United Russia party lost two local mayoral elections in restive eastern provinces, leading President Medvedev to introduce legislation that would allow provincial governors (appointed by the Kremlin) to replace democratically-elected officials at the local level. This follows brutal crackdowns on protestors; Moscow has become so sensitive to the risk of popular unrest that it recently flew special forces thousands of miles to snuff out local protests against rising tarriffs.

These examples seem to foreshadow a global summer of discontent as unemployment rises and government budgets come under greater pressure. This poses obvious risks to political stability and commerce. It also constrains the options available to policymakers, making beggar-thy-neighbor actions such as the imposition of trade barriers, subsidization or nationalization of industries and currency devaluation more likely. History tells us that these domestic political considerations, particularly in the developing world, risk reinforcing the downward economic spiral, as policymakers appease factions and fail to reach coordinated regional/global programs. They also risk, particularly in the case of currency devaluations, setting off a change reaction of competitive responses that, in the absence of regional cooperation, ultimately destabilizes the system as a whole.

The potential impact of growing popular unrest cannot be overstated. While violent inter-state conflict seems only likely over energy resources, the damage from economic warfare is still profound. Intelligence services have come to recognize this threat. In testimony before the US Congress, Director of National Intelligence Dennis Blair identified the financial crisis as the single greatest national security threat to the United States, before Al-Qaeda or nuclear proliferation. President Obama now receives a daily economic intelligence briefing from the CIA in addition to his traditional daily intelligence briefing. Economic and national security considerations have converged in the eyes of intelligence analysts and policymakers. One has to wonder whether this will lead to more mercantilist policy agendas as liberal economics loses credibility, multilateral cooperation stalls and popular discontent grows.

As we try to come to terms with the crisis and its implications, IPE, as an academic discipline, is well-positioned to explain and guide us through this complex global environment. The discipline arguably isolated itself for many decades as it sought to distinguish its theories from the traditional IR, realist paradigm that dominated both academic and official thinking during the 20th century. It discounted security considerations too much, pushing an almost Marxist-like bottom-line: the economic drives the political. But since the end of the Cold War the discipline has developed a greater appreciation for the security implications, and influences, within the global political economy. Freed from its self-imposed intellectual box, IPE now offers the most multidimensional, comprehensive analytical framework for conceptualizing and forecasting the economic and political consequences of the current crisis. I would guess that more than a few IPE grads will be drafted into their respective national intelligence services in the coming years.

It has become cliche to say we are witnessing a global paradigm shift. But as the crisis plays out over the coming months, and political instability spreads, it will become ever more apparent that one cannot divorce economic conditions from national security. The risk is that this realization leads policymakers to adopt mercantilist policies and abandon multilateral cooperation. Amidst growing protests, the difficulty policymakers face in fashioning a global consensus on regulatory reform and economic stimulus only hardens. Upon this backdrop, the G20 meeting in London develops an even greater sense of urgency. Our leaders must sieze the moment. Their window may be closing.

In Defence of Protectionism: A Thought Experiment

One of the most consistently rewarding (non-IPE) blogs I read is the excellent Overcoming Bias. As you might guess from the title of the blog, they regularly suggest ideas and strategies for critical self-examination, as well as other philosphical musings. A recent post recommended trying to write a hypothetical apostasy: take a complex debate over some topic or "ism" about which you've already made up your mind and have defended vigorously, and argue the opposite. Also: the fate of the world depends upon how convincing your arguments are to a jury that's already skeptical about your motivations.

So let's try this out with one topic that we've been hammering on about for quite some time: the value of free trade over protectionism. Here is a set of arguments on why a faith-based defense of free trade is problematic.

Bang for Buck - Paul Krugman has pointed out that, if you lack a set of internationally coordinated stimulus measures (like now), then the problem with injecting money into your economy is that some of it will be spent on the products of other economies (imports). And yet, the entire debt burden of additional spending falls upon the shoulders of the government that actually spends the stimulus money. The result is less-than-sufficient fiscal stimulus and a global economy that recovers very slowly.

If, however, every country shut down its economic borders and focuses on stimulating the local economy, then in theory, "protectionism can make the world as a whole better off." It's a second-best solution, but perhaps more politically feasible than international coordination.

Defense - What good is creating a wealthy society that cannot defend itself from aggressors? Some aspects of economic activity are crucial to defending the livelihood of society, and should thus be protected from foreign competition. Even Adam Smith, the prophet of free-marketeers, recognized the importance of Britain's navy to its overall wellbeing: "As defence, however, is of much more importance than opulence, the [monopolistic] act of nagivation is, perhaps, the wisest of all the commercial regulations of England." We've moved from sail-powered to nuclear-powered ships, but the principle is the same.

Monopoly - If a country possesses a monopoly over the production and sale of a particular good or service, there may very well be a higher marginal rate of return if prices are artificially raised by a tariff or something similar. With freer trade, those monopoly rents would disappear.

Development - The Ricardian model of comparative advantage that is taught in ECON1000 courses to explain why free trade works is oversimplified. Among other things, it assumes frictionless trade between economies. The reality of international trade is very different (see Dani Rodrik). Despite the progress achieved through the WTO, there remain high transaction costs for international trade. Moreover, labour mobility is still heavily restricted, which disadvantages poorer, labour-rich economies.

In this non-idealized world, trade is concentrated between OECD countries and capital is actually going from developing to developed parts of the world. Put another way, the gains from trade are skewed towards the already-rich countries. Yes, it's true that emerging markets like Japan, South Korea, Taiwan and now China and India have achieved remarkable growth in recent years, but each of these deviated from the ideal free trade model. Japan had state-supported export industries and lived under an American security shield during its period of boom. Ditto with South Korea and Taiwan, although with some variation. China kept very tight control over its economic direction during its coming out decade of the 1990s and only now, once it established itself as an economic power, has it begun it loosen some of the protectionist barriers.

Go further back in history and you see how the Dutch, then the British, then the Americans all used monopolistic and protectionist approaches to economic policy - this was part of the package that helped them grow to the industrial powers of their day. In short, protectionism is part of any smart development strategy.

Protectionism-as-threat - It can be used to threaten other nations to back off from beggar-thy-neighbour policies. Protectionism can also be a tool to pry open foreign markets.

Equality - Free trade rests upon the principle of comparative advantage, and comparative advantage means specializing in what you produce most efficiently. If your economy is best at jobs requiring highly-skilled and highly-educated workers, then further specialization will disadvantage the less-skilled, less-educated workers and vice versa. "Retraining programs" are of limited value, especially for older workers. And if a factory-town loses its factory because of international competition, there are serious limitations to how easily former factory workers can learn to become software engineers or whatever. These are the real, human costs.

Ardent free traders insist that these costs are offset by economy-wide gains "a rising tide raises all boats." Let's leave aside for the moment the argument that the gains from more affordable toys for you kids is more than offset by the loss of your job - that's obvious. But there is evidence suggesting that the gains from trade are not all they're cracked up to be.

Take Mexico. Since the implementation of NAFTA, Mexico's GDP growth has not really been all that impressive. Yes, the export industry has grown and, yes, FDI has gone up. But economic growth has not been sufficient to address unemployment concerns in the country, and free trade has altered the structure of the economy. Have a glance at the concluding remarks of a 2005 UN-sponsored study on the post-NAFTA Mexican economy:

...the elimination of most fiscal and financial subsidies put a strain on the manufacturing sector’s relative rate of return. And although financial liberalization led to a serious restructuring of Mexico’s banking sector, domestic credit for productive activities and for investment has been severely rationed for the last ten years....
Thus a dual structure has been taking shape in Mexico's manufacturing sector. On the one hand, there are a few very large firms whose links with transnational corporations (TNCs) and access to foreign capital have helped them to become important players in export markets; on theother hand, vast numbers of medium and small firms struggle to survive the intensified pressure from their external competitors.

Meanwhile, the gini-coefficient, has shot through the roof - just as it has in China.

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Note that few of these arguments dispute the underlying logic of free trade theory, strictly speaking; these are instead exceptions to the theory or political economy realities which fall outside of the theory's scope. But these exceptions to the theory are ubiquitous in the real world of economic affairs, which means they need to be addressed. If NAFTA isn't doing for Mexico what it said on the box, simply re-iterating Ricardo's arguments or shouting "Heretic!" at all those who point out this inconvenient fact is not helping.

We need to tackle the tough questions, and that means tempering our dogmatic oversimplification that free trade = good, protectionism = bad. Economic history shows that things are messier than that, and that in many cases, the gains from free trade have been oversold.

That Was The Week That Was

Politique
-G7 finance ministers meet in Rome following the passage of an $787bn US stimulus package. US Treasury Secretary Geithner received a not-so welcome reception at the meeting, with some ministers critical of the US deficit and "Buy America(n)" provision present in the final bill. While the meeting provided window treatment to the tensions over protectionism, it is clear that a substantive lack of coordination and consensus is setting the global economy up for a period of tense economic relations. G7 communique text here.

-The Israeli election ended in a stalemate as Kadima won a shock 1-seat minority victory over Likud. The insurgent candidacy of far-right party Yisrael Beitenu and its leader Lieberman shook the political establishment, banishing Labour to the political wilderness and winning the key to an eventual coalition government.

-Venezuelans voted again on abolishing term limits. Chavez has raised tensions in the run up to this vote by denouncing an opposition and US-led "coup" plot.

-For the first time, Pakistan officially acknowledged that "some part of the conspiracy" against Mumbai was carried out on its soil.

Economia
-US Treasury secretary Geithner unveiled an "outline" of the Obama administration's financial system rescue plan. The heavy on intentions, light on details presentation was immediately rebuffed by markets, commentators and policymakers begging for more clarity and substance.

-Karl-Theodore zu Guttenberg assumed the economic portfolio in Angela Merkel's coalition. The move comes less than a week after it was announced that German industrial output fell in December by its largest margin since unification.

-In testimony before Congress, US director of national intelligence Dennis C. Blair said that the global economic crisis was the most urgent threat to US, and global, security. The global political instability, economic uncertainty and diminished US authority stemming from the crisis surpassed the threats posed by terrorism and nuclear proliferation.

The Rest
-In the FA Cup, Everton beat Villa, ManU over Derby, and Swansea forced a replay against Fulham at the Cottage. In other Prem news, Big Phil went bye bye. In Serie A, Becks looked set to return to L.A. after the MLS imposed Friday deadline (or tactic?) passed without a deal. In Spain, Raul broke the all-time goals record at Real Madrid.

-In the biggest study of its kind, researchers found that regular multivitamin use did little to prevent cancer or heart disease in older women.

-Walking down Amsterdam Avenue in Manhattan yesterday, my wife and I stumbled upon a disheveled, mad scientist looking Malcolm Gladwell. As we approached the best-selling author, he very clearly slowed down to walk parallel to us, awkwardly incapable of disguising the fact that he was eavesdropping on our animated, but admittedly unremarkable, conversation. I am convinced that we are now the subject of his next book, Caring for the Elderly, and demand royalties.

The Debate Continues...

...on protectionism. First off we have the indefatiguable free-trade defender Jagdish Bhagwati who is, well, defending free trade. Even if the US enacted measures that were WTO-consistent, Bhagwati points out that other countries could do the same:

Nothing would prevent India and China from choosing to raise tariffs thus on items of export interest to the US. Besides, they could shift their own purchases of aircraft away from Boeing to Airbus, and of nuclear reactors from American to French companies. The response would, of course, be for the enraged US congressmen to start enacting their own retaliation. The game would become lively.

In the interest of balance, I point you to a column by Oxfam's Duncan Green that argues that protectionism is not all bad, particularly for developing countries. I had the pleasure of having Duncan give a guest lecture in one of my graduate school classes - he offered a refreshingly blunt assessment of what it was like to work for an NGO, both good and bad.

As far as his argument goes, I think he's in good intellectual company when he points out that the poorest developing countries may need trade barriers to help them escape from a poverty trap. I think the well-respected development economist Paul Collier argues as much in The Bottom Billion. To be fair, however, we've been focusing our criticism on the Buy America, Buy China and Buy India type policies enacted by members of the G20. For these countries, at least, Duncan thinks protectionism is a rotten idea.

...and on fiscal stimulus. There's no end to the material provided by all sides of this lively discussion, but I particularly enjoyed this sarcastic op-ed by Benn Steil:

Citing Keynes gives us special licence to talk economics without using any. To paraphrase the lawyers’ dictum, when the facts are on our side, we pound the facts; when theory is on our side, we pound theory; and when neither the facts nor theory are on our side, we pound Keynes – and to great effect.

I think that Keynes is right when it comes to the need compensate for market downturns through active policy measures, rather than simply waiting things out, and Stein takes Keynes' quote about how "in the long run we are dead" out of context. But his target is not so much some long-dead economist but rather the people who are inclined to use the name of some long-dead economist as justification for spending our money. Just because there is a clear need to "do something" significant doesn't mean our legislators should be given a free reign. With huge stimulus packages being proposed by almost every major Western government, it has become more important than ever to ensure that the money is A) being spent on what's being promised, B) having the effect that's promised, and C) not mortgaging our financial future in the process.

Easier said than done.

Update: Brad DeLong retorts to the Steil piece.

Finally, someone in charge unequivocally denounces "Buy America(n)"

From Dallas Federal Reserve President Richard Fischer:

"Let me just be blunt. Protectionism is the crack cocaine of economics. It may provide a high. It's addictive and it leads to economic death"

Editor's note: the provision in question has been alternately referred to as "Buy America" or "Buy American." I started using "Buy America" because Reuters (the source of my initial post on the provision) does. However, it seems "Buy American" is more widely used.

Legendary journalist William Safire has a weekly column in the New York Times Sunday Magazine called, "On Language", in which he explores the origins, meanings, and uses of popular words or phrases. I think the "Buy America"/"Buy American" distinction would be an interesting case. While the essence is the same, does the addition of the 'n' alter the implied scope or meaning in some subtle way? Sadly, I can't answer that.

Monday Morning Round-Up: UK Frozen Assets & more

- Oh how I wish I wish this had happened while I was living in London: the heaviest snowfall in almost two decades has hit the UK capital. I've always wondered how the City workers would react to snowfall and now we've found out: they take a "snow day" - to the cost of about 1 billion pounds. (Here's a slideshow, and more funny)

- Anti-protectionist writing continues to pour out of the economic blogosphere. You can find a writer at Free Exchange dismantling the populist argument here; the Davos crowd is understandably nervous, and Willem Buiter is his usual, uncompromising self. A sample:

If anything like the Buy American clause inserted by the House survives in the bill president Obama gets on his desk, he must veto it. The questionable value of the fiscal stimulus is overwhelmed by the unquestionable domestic and global harm caused by the Buy American clause. If president Obama fails to veto a protectionism-laced bill, it will be clear that we have a wuss in the White House.

- China's manufacturing sector contracted for the sixth consecutive month in January. But in fact the trend is much wider than that, and much worse. Cue the trade war.

US Steel Proposes To Build 'Negative Railway'

Rory and I have both made our views clear on the recent resurgence of protectionist measures in G20 countries so, instead of spouting off once more, I think it's worth looking at the arguments at work on both sides. Via Megan McArdle:

Proponents of expanding the "Buy American" provisions enacted during the Great Depression, including steel and iron manufacturers and labor unions, argue that it is the only way to ensure that the stimulus creates jobs at home and not overseas.... The proposals are meant to regenerate heavy manufacturing jobs in the United States by forcing government contractors to use domestic materials and equipment, even if they are more expensive.

The logic here is that, in order to prevent stimulus money from leaking abroad, one must spend money on domestic goods. These are, after all, the workers and firms who are going to be hard-hit by this recession. But does anyone else find it odd that these proponents are suggesting that the best way to deal with a consumer-driven recession is to make things that are more expensive? And yet that's what we're seeing once again with the proposed additions to the economic stimulus package that was voted through the US House of Representatives yesterday (see Rory's post below).

It's interesting to see how the arguments for protectionism have changed so little over the years. Thanks to the wonders of the internet, I have managed to track down a biting critique of protectionist logic by 19th century French writer Frédéric Bastiat. In his book, Economic Sophisms, (available at EconLib) Bastiat used his humour and wit to ridicule the policy proposals of his day. Below is Bastiat's essay: "A Negative Railroad" - see if you can draw parallels with today!

I have said that as long as one has regard, as unfortunately happens, only to the interest of the producer, it is impossible to avoid running counter to the general interest, since the producer, as such, demands nothing but the multiplication of obstacles, wants, and efforts.

I find a remarkable illustration of this in a Bordeaux newspaper. M. Simiot raises the following question:
Should there be a break in the tracks at Bordeaux on the railroad from Paris to Spain? He answers the question in the affirmative and offers a number of reasons, of which I propose to examine only this:

There should be a break in the railroad from Paris to Bayonne at Bordeaux; for, if goods and passengers are forced to stop at that city, this will be profitable for boatmen, porters, owners of hotels, etc. Here again we see clearly how the interests of those who perform services are given priority over the interests of the consumers.

But if Bordeaux has a right to profit from a break in the tracks, and if this profit is consistent with the public interest, then Angoulême, Poitiers, Tours, Orléans, and, in fact, all the intermediate points, including Ruffec, Châtellerault, etc., etc., ought also to demand breaks in the tracks, on the ground of the general interest—in the interest, that is, of domestic industry—for the more there are of these breaks in the line, the greater will be the amount paid for storage, porters, and cartage at every point along the way. By this means, we shall end by having a railroad composed of a whole series of breaks in the tracks, i.e., a negative railroad.

Whatever the protectionists may say, it is no less certain that the basic principle of restriction is the same as the basic principle of breaks in the tracks: the sacrifice of the consumer to the producer, of the end to the means.

House passes "Buy America" clause, EC takes notice

On Wednesday I poked fun at the hypocrisy of Vladimir Putin's Davos speech. Despite this, his warning on the dangers of protectionism should be heeded by policymakers, particularly in the US, especially now.

The US House yesterday passed the $819 billion stimulus package, known as the American Recovery and Reinvestment Plan (I love the use of the word "reinvestment", you just know it focus-grouped so much better than "exploding deficit"). The vote was along party lines; not a single Republican voted for the package. The debate over the contents and balance of spending/tax cuts is endless, and I won't wade into those waters here. But I am very troubled by one aspect of the bill: the now notorious "Buy America" clause (which, I must boast, I was all over from the beginning). What at first looked like a shameful attempt at backdoor protectionism, is now officially on the table. It passed.

We know that the House version of the bill is different from the one the President will ultimately sign. It is likely that many of the "pork-lite" programs will be shed to deflect widespread criticism over their relevance to the immediate economic crisis. But in all the partisan back and forth, I have yet to hear a passionate criticism of the "Buy America" clause. The Republicans are more outraged by $335m in funding for sexual health education and prevention programs. The silence on "Buy America" is dangerous and increases the likelihood that the clause remains in the final version. It also provides a fundamental test of Obama's trade policy, whatever that might be. Megan McArdle and Dani Rodrik agree.

Luckily, the European Commission has a bit of a problem with "Buy America" (Canada too). Peter Powers, Commission spokesman, warned, "If a bill is passed which prohibits the sale or purchase of European goods on American territory, that is not something we will stand idly by and ignore." Furthermore, the European Confederation of Iron and Steel Industries (Eurofer), a powerful lobby representing over 370,000 EU workers, has called on the EU to bring it to the WTO, saying, "Our view is that if passed this would be a clear violation of their WTO commitments on government procurement rules", and, "It is a protectionist measure which goes against the commitment made to the G-20 to keep markets open."

Dave was spot on when he said of this rising protectionism, "the real danger is that tariffs/bans on stuffed kittens and fancy cheese are the first snowballs that kick off an avalanche of protectionism that smothers trade and damages geopolitical relations." But what if that avalanche is exactly what we need? Could "Buy America", cheese duties, and stuffed kitten tariffs be the sparks that finally break the DDA deadlock? A rapid deterioration in the trading system could compel leaders to look past the modalities and embrace the central role of trade in saving the global economy.

Maybe. We've learned that a crisis is often necessary to force policymakers out of their comfort zones and stand up to powerful interests. At the very least, a little pressure from the across the Atlantic might bring US policymakers to their senses.

UPDATE: The FT reports that the "Buy America" clause is not present in the current Senate bill, but Senators like Sherrod Brown of Ohio are pushing for its inclusion. I mistakenly assumed it was.

(Photo: funkandjazz)

Vladimir Putin: "Don't do as we do...we do it best!"

Russian Prime Minister Vladimir Putin used his podium at the World Economic Forum to attack the dollar's supremacy, skewer Wall Street bankers, and call for a new global energy paradigm. He also layed the smack down on Michael Dell.

But it was his warning against excessive state intervention in response to the global economic crisis that really caught my attention. His statement was, um, interesting:

"Excessive intervention in economic activity and blind faith in the state’s omnipotence is another possible mistake."

Huh. Putin, excessive intervention, blind faith in state's omnipotence. I feel like these things are related.

India Toys With Protectionism

For those you with short memories: a reminder about the G20 meeting from late 2008. Among the many fine words put forward following the November summit, there is one collection that seems worth revisiting. Declaration #13 reads (ahem):

We underscore the critical importance of rejecting protectionism and not turning inward in times of financial uncertainty. In this regard, within the next 12 months, we will refrain from raising new barriers to investment or to trade in goods and services, imposing new export restrictions, or implementing World Trade Organization (WTO) inconsistent measures to stimulate exports.

Given the near-universal consensus on the detrimental contagion effects that protectionist measures have on global trade and material well-being, this was not particularly earth-shattering. Still, it was nice to see our political leaders re-affirming their commitment to...

Oh bugger! it took only three days before we heard serious talk in America about bailing out the automotive industry. This was followed shortly by the lawmakers considering a "buy US steel provision" for TARP funds. Meanwhile, in China, there is the small matter of currency manipulation and using the fiscal stimulus plan to promote domestic industries.

Not to be outdone, India has stepped up to the protectionist plate (wicket?) to take a few swings. Yesterday, India's government banned Chinese toy imports for six months - all six which fall into the twelve month period of no-import barriers promised above. From Free Exchange:

What the [Indian] government is thinking is unclear. In a grave speech at the G20 meeting in November, India’s prime minister urged the group to "forestall any protectionist tendencies which always surface in times of recession". The G20 seems to take India seriously. But India doesn’t seem to feel the same way about the G20.

Unfortunately, the same can be said for many of the G20's members. Of course, if all Chinese toys posed a serious health hazard in some way maybe this could be justified. But is it likely that all Chinese toys are dangerous? If so, India's government should be presenting their evidence to the WTO, not taking the path of least domestic political resistance and implementing a complete ban. Incidentally, this is also the path towards a trade war with one of the world's largest exporters.

Now I'm guessing the toy industry does not represent a significant portion of China's GDP, but that's not really the point. As The Economist's in-depth look at the infamous Smoot-Hawley bill of 1930 made clear, the real damage comes from how such laws sour trade relations, leading to retaliatory effects. Just look at what happened last week with French cheese.

So let's leave aside for the moment how such actions undermine the G20 and provide yet further evidence for the calculated hypocrisy of our political leadership. The real danger is that tariffs/bans on stuffed kittens and fancy cheese are the first snowballs that kick off an avalanche of protectionism that smothers trade and damages geopolitical relations. It is precisely now, in this economic turmoil, when international cooperation is needed more than ever.

Culture wars, of a different kind

According to the Times of London, one of former US President Bush's final acts in office was a 300% increase on the punitive duty on Roquefort cheese imports from France. Mmmm, cheese.

Anyway, this was accompanied by increases on a variety of EU food imports, including fruit, chocolate, and chewing gum. The Times reports this as further punishment for Europe's 12 year ban on US hormone-fed beef. Some in France believe it extends back to France's lack of support for the invasion of Iraq. If true, US logic is brilliant- hit them where it hurts...cheese!

As if the new US duties weren't troubling enough, the European reaction threatens to ignite a full blown culture war. From the Times:

Philippe Folliot, a centrist MP for the area around the village of Roquefort, called for a super-tax against Coca-Cola.

Touche, France.

The slippery slope to protectionism or How to create your own depression

The interwar period is a fascinating "topic" in IPE. Scholarship on the period is vast, offering multiple explanations for the trends, events and ideas that contributed to the Great Depression and WWII. Some of the great thinkers in IPE (such as Kindleberger, Eichengreen and some guy named Bernanke) have contributed to the analysis of the period.

The interwar period is studied so closely because it provides lessons on how NOT to respond to economic contraction and financial crisis. If this history is any indication, protectionism should be avoided like the plague. The Smoot-Hawley tariff set off a change reaction of protectionism from 1930 on that plunged the world much deeper into depression. While a global (meaning British and American) consensus on trade was unattainable immediately following the war (see ITO failure), the GATT succeeded largely due to the Anglo-American recognition that tariffs were dangerous to economic recovery, prosperity and peace itself.

Over the next few weeks, the Obama transition team and US Congress would do well to brush up on their interwar history. The US steel industry, after years of benefiting from illegal subsidies, are reportedly lobbying in favor of a massive public works plan that would have a "buy US" provision inserted into every project. This would conceivably require the recipients of federal funds for public works and infrastructure projects to purchase US steel.

The proposal is troubling on a number of levels. For one, it would prove that the TARP was but the tip of an iceberg of government subsidy. Banks, autos, steel...where does it end? Second, it underlines the risks posed by the DDA's failure. WTO and G20 indecision in the face of rising protectionism risks exactly the domino effect that Smoot-Hawley accelerated nearly 80 years ago. Finally, a "buy US" clause would be a dangerous precedent for the President-elect to set. Many are already skeptical of his commitment to a liberal trading system, and early support for such backdoor protectionism would do little to burnish his trade credentials internationally.

Vice-President elect Biden believes that to be credible and effective, the Economic Recovery Plan must be "pork-free". It is equally important that it avoid the kind of backdoor protectionism the US steel industry is lobbying for.

Thomas Friedman on the auto bail-out

I don't read Thomas Friedman that often. I always found his "flat-world" theory to be lacking an appreciation for the asymmetries in the international political economy. I think a world of "peaks and valleys" is a more appropriate image. But who am I? Friedman's sold a billion books, won multiple Pulitzers, and is rumored to garner circa $50,000 per speaking engagement. Obviously, he's doing something right.

But I do read Dave Hart (regularly in fact), whose great piece on the Big-3 got me traversing the internets for opinion on the prospects of an automotive bailout. This led me to Friedman, whose recent media crusade against the US auto industry I find spot on. His 11/11/08 NYT column, "How to Fix a Flat", sums up his criticism of the US Big-3 automakers:

for years, executives, lobbyists, and Congress (in particular the Michigan delegation) have sheltered these companies from the need to innovate or die. The have been allowed to resist higher environmental and fuel-efficiency standards, and implement bone-headed strategies that prioritized the SUV over hybrid or smaller, fuel-efficient vehicles. And now, as their business model, balance sheets, and beloved SUVs are forcing them into bankruptcy, these companies feel entitled to a taxpayer-funded bail-out?

I share Friedman's (admittedly, everyone's) outrage. I recognize the risks to the real-economy of their bankruptcy. Millions of workers (if you include suppliers) would lose their jobs in a period of rapidly rising unemployment and deflation. I also believe that the sensible arguments against Chapter 11 are important: in the current credit environment, Chapter 11 restructuring might be impossible, giving way to Chapter 7 and the worst-case scenario. But what is the chance that these companies will be compelled into any of the necessary restructuring in exchange for further financial assistance? Remember, the US government has been bailing these bozos out for decades, and what have we received in return? Sasquatch.

As Clusterstock pointed out, a short/medium-term cost benefit analysis might fall in favor of a bail-out. But what then? The shield that would be erected around these three posterchilds of protectionism would take decades to dismantle. The union contracts would remain largely in tact (not a chance Dems are jeopardizing the Rust Belt in 2010)*. CAFE standards are already (predictably) being vilified by the auto companies.

The US economy can't afford an industry collapse. But taxpayers can't afford another waisted bailout. If they agree to the thorough concessions and restructuring Friedman and Ingrassia call for, then bail em out. If they don't, let creative destruction work, and follow Friedman's advice. Allow Chapter 11, compel independent administration, and set these companies toward a restructuring process long overdue. One company might go into bankruptcy, but like the investment banks after Lehman, the others will quickly fall in line and accept strict conditions to assistance.

We must also renegotiate the contracts of remaining workers (on fair terms- whatever those are), increase unemployment benefits, and retrain those who are laid off in green jobs or re-employ them in a massive infrastructure-based stimulus project. And how about universal health care reform as well?

We need the political will (finally) to confront the auto industry and dictate the terms of assistance. This means confronting their stubborness head on. It may be risky, but its a risk worth taking.