THE BEAR'S LAIR The rising protectionist tide
By Martin Hutchinson
The credit crisis has taken an ugly turn, with a number of countries banning
rice exports, causing the price of the staple to soar above US$1,000 per tonne,
treble its level a year ago. Politically and economically, the world has moved
decisively in the direction of protectionism and seems likely to continue
further along the protectionist path. It's worth looking at what this trend may
entail and how we might minimize its costs.
The most damaging aspect of the current burst of protectionism is the refusal
by countries supplying food staples to export to their usual customers; this
could actually make people starve.
It is worth noting that this crisis is almost entirely the result of
government action. First, the George W Bush administration and the European
Union instituted counterproductive (both environmentally and economically)
subsidies for ethanol production, by means far less efficient than the sugar
cane-based ethanol being produced in Brazil. That caused a supply shortage in
corn and other crops that would not otherwise have occurred.
Second, governments, especially the United States, printed excessive amounts of
fiat money, causing an immense speculative bubble. Finally, the panic was
exacerbated by an unwise speech by public sector bureaucrat, World Bank
president Robert Zoellick, who advocated a "new deal" for world food
production, inevitably involving vast taxpayer subsidies through the World
Bank, and thereby turned popular concern about price rises into panic.
This is not to say that globalization itself has been an unqualified success.
The idea that, by totally freeing trade, immigration and investment wealth
could be optimized at low cost is a fantasy beloved only by academic
economists. In reality, globalization of immigration, investment and trade each
involves tradeoffs, and the tradeoffs are different, since each has different
characteristics. Only by treating each factor separately and by taking
seriously the arguments both popular and economic against its globalization,
can truly damaging protectionism be resisted.
In the case of trade, David Ricardo's 1817 Doctrine of Comparative Advantage
states that each product should be manufactured in the country where its
relative production cost is least and that such an arrangement is optimal for
all. This is however a purely static analysis that ignores the tendency of
national capabilities to change over time.
Benefits in doubt
In the modern world, with rapid transportation, good education systems and
instant communications, such capabilities can change very rapidly. There is
thus no assurance that outsourcing computer software production to India, or
high-tech manufacturing to China, will in reality produce benefits for the
outsourcing countries.
Indian computer software writers and Chinese high-tech engineers may simply
acquire the techniques and know-how they need and set up in competition.
Globalization of trade is generally beneficial to inhabitants even of rich
countries (the benefits of cheaper garments and electronic goods are
undoubted), but the losers are not simply concentrated in dying industries.
They may be the apparently successful toilers in growth sectors.
Another problem with global free trade, becoming increasingly apparent, is that
of global monopolies or oligopolies. Once an industry becomes globally
oligopolistic the rules of free competition tending to reduce prices and
increase quality become less salient, and the benefits of further globalization
can no longer be assured.
In aircraft, for example, it is not clear that the world benefits from having
only two major civil aircraft manufacturers. Similarly in financial services,
the growth and globalization of financial service providers has meant that when
a downturn occurs, it is global in scope and produces problems of illiquidity
in markets far distant from those in which the problem initiated.
It is a complete mystery why the Japanese stock market should have dropped 25%
in the first quarter of 2008 when its banks had little exposure to the US
housing sector and its economy was continuing to grow satisfactorily. Steel,
oil and mineral extraction are other sectors in which globalization appears
problematic, although in automobiles a welcome contrary tendency has appeared
of new manufacturers in emerging markets themselves achieving the scale and
capabilities necessary to compete internationally.
Freedom of investment is another principle much beloved by theoreticians that
in practice causes difficulties. The problem is that economics does not exist
in a vacuum from foreign policy. In natural resources, for example, the normal
ambition of most Third World governments is to seize control of any minerals
discovered on their territory. Given that tendency and the existence of
companies controlled or effectively controlled by governments hostile to
Western interests, free foreign investment is a chimera.
On the other hand, since its problems are political rather than economic, free
foreign investment remains an appropriate ideal to establish. The two caveats
should be national security, broadly defined, and the need to avoid monopolies,
whether global, as in aircraft, or regional, as in Russia’s attempt to dominate
the European gas market.
Weak case for unrestricted immigration
The case for unrestricted immigration is much weaker than that for free trade
and its damage to the high-wage host country much more obvious. Because of the
fierce competition produced by global free trade, wages for the unskilled in a
completely free world market are driven down to subsistence levels. Malthus
said this in 1798 and given the excessive global population growth produced by
modern medicine it remains true. Even globally, the modest overall income
improvement from the equalizing effect of free immigration is overwhelmed by
its huge and unattractive social costs, which impose economic penalties in the
form of crime, unemployment and ghettoization
To protect the lower-skilled inhabitants of rich countries and prevent
intolerable social strains through Latin American-style income differentials
within society, it is thus necessary to restrict immigration. The barber in
Boston makes 10 times the wage of the barber providing an identical service in
Lagos; it is appropriate that he should. Fantasizing that the low-skill worker
should get an education making him superior to his immigrant competitor is
elitist nonsense; if he'd been able to get into Harvard he would have gone
there, while further years of drudgery at a community college are not going to
provide him with any significant extra competitive ability.
At the high-skill level, the much-lamented shortage of US engineers and surplus
of lawyers is almost entirely due to the H1B visa system, which allows in
competitors to graduate engineers, driving down their wages, while preventing
easy qualification by foreign graduate lawyers, giving domestic lawyers a
protected position.
However fallible free-trade theories are, most protectionist policies offer no
chance of improvement. In general, markets work better than governments, which
is why free trade was thought to be optimal in the first place. Modified free
trade, in the form of the current cat’s cradle of bilateral agreements,
subsidies for non-economic objectives and deals like the Colombia and Korea
Free Trade Agreements that may sometime pass Congress but not anytime soon,
adds substantial costs to the world economy without providing the protections
against unfettered competition that a suspicious public demands.
Autarky, the policy favored by Third World governments that generally see
chances of self-enrichment from imposing restrictions, is to be fought. Autarky
in natural resources reduces production, since it prevents the latest
technology from being brought to bear on the complex questions of exploration
and extraction maximization.
The current trend for countries to take increasing control over their own oil
resources, forcing out the multinationals, is the one thing that could truly
bring the "Peak Oil" nightmare to pass, a future in which we are condemned to
use ever-diminishing supplies of oil without yet having discovered adequate
substitutes.
Russian oil production, thought to be the great new "swing source" of
non-Organization of Petroleum Exporting Countries expansion, appears to have
peaked in the face of expropriation and embezzlement, while autarkic Mexico,
Nigeria and Venezuela have all seen substantial recent production declines in
spite of high prices. There are a few counterexamples: Iraq's oil reserves have
doubled since grown-up oil companies were allowed back to explore there in
2003, while recent Brazilian oil discoveries have been substantial because
Petrobras has become open to foreign exploration and production partners.
Subsidies - at a price
In food, autarky is hugely counterproductive; the riots in rice-consuming
countries because of export bans by rice-surplus countries are the starkest
recent example of protectionism's many downsides. Subsidy programs rapidly
become inordinately expensive as prices rise, and by subsidizing the
consumption of temporarily scarce goods they exacerbate the shortages that
produced the initial price rises.
Even in manufactured goods, where it was once thought desirable for every Third
World country to have its own steel mill, autarky can impose huge costs for
very little if any benefit. Governments are no better at choosing winning
sectors than they are at setting prices; the results of their failure are
legion, and their costs are generally far greater than those imposed by
excessive free trade.
Since unrestricted globalization imposes substantial costs, and unreflective
protectionism imposes even greater ones, we need to find a solution that
modifies globalization to restrain the costs it imposes without losing its
benefits. As far as possible, that solution should be market-driven rather than
government-led, and it must recognize that trade, international investment and
immigration, while related questions, have differing characteristics that need
to be recognized.
The Doha Round of trade talks should be revived, partly because trade talks
appear to have the "bicycle" quality that motion itself is beneficial. Because
it ensures that countries of all economic positions attempt to reach agreement,
a Doha agreement, and even the Doha process, is far more beneficial to world
trade than a series of bilateral deals that attempt to discriminate unfairly
against third parties. Colombia can feel itself aggrieved if the US does not
ratify its FTA, because Peru, Panama, Mexico and Central America all have FTAs
with the United States, giving them a politically and economically unjustified
advantage against Colombia in selling goods and services to the US and
attracting investment from it.
However, the strong focus of the revived Doha talks should be on reducing the
politically directed high tariff barriers in such areas as agriculture, and on
banning subsidies, rather than on lowering modest general tariffs. In a world
of freely floating exchange rates, without a gold standard or equivalent, there
is a substantial economic case for moderate tariffs, which preserve each
country or trading bloc’s home market as a protected area, preventing temporary
fluctuations in exchange rates from driving almost-competitive local producers
out of business.
If the euro/dollar exchange rate can move in six years from $0.85 to $1.60
without any significant differentials in inflation, there needs to be a
mechanism preventing unnecessary bankruptcies and forced sales of companies
trapped on the wrong side of an extreme exchange rate. By definition, the
additional costs imposed by a modest tariff will be modest, and it will tend to
lessen oligopolization of global production, since each producer will have a
competitive advantage in its own country/bloc.
Whereas tariffs provide revenue to feed the ever-expanding maw of government,
subsidies cost money and are thus doubly damaging both to taxpayers and the
world economy. It is not surprising that the Doha talks are moribund. The
attitude of the Bush administration and the EU, in expanding agriculture
subsidies and inventing an entirely new and pernicious subsidy for ethanol
production, while piously claiming to favor free trade, reached levels of
hypocrisy and economic illiteracy that the Brazilian, Malian or Indian
delegations could not be expected to stomach.
Interest rates must rise
A further need is for higher worldwide interest rates and lower worldwide
liquidity. Much of the recent run-up in commodity prices has been due to
excessive economic expansion, combined with over-abundant capital for
speculators seeking to exacerbate price movements.
A global tightening of interest rates, beginning in the United States, where
the economic imbalance is greatest, will rapidly reduce the fever in
commodities markets, thereby reducing the temptation towards autarky. It will
also rebalance the US trade deficit, which will lessen the non-market central
bank demand for Treasury securities, forcing a tightening of the excessively
expansionary US fiscal position.
Immigration is the area where restrictions are most beneficial to the
less-educated populations of rich countries because it attacks the huge sector
of the economy that is not internationally tradable. Immigration should thus be
tightly restricted, both at the high-skill and low-skill levels, with tight
quotas for the former and tight restrictions against illegal entry by the
latter.
Globalization in its extreme form has failed and could never have succeeded. We
in the rich West now need to ensure that the inevitable reaction towards
protectionism provides the maximum protection of Western living standards at
the minimum possible global economic cost.
Martin Hutchinson is the author of Great Conservatives (Academica
Press, 2005) - details can be found at www.greatconservatives.com.
(Republished with permission from
PrudentBear.com. Copyright 2005-07 David W Tice &
Associates.)
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