Is a Global Trade War Brewing?

We certainly hope not, but this story, among others, caught our eye (emphasis added):

Many industry representatives are apprehensive about the new year. With unemployment rising, the new Democratic-controlled Congress is expected to be less amenable to new trade agreements than was its predecessor. Public Citizen’s Global Trade Watch says the ranks of trade liberalization opponents had a net gain of 28 votes in the House and six in the Senate, figures business community representatives, such as the National Foreign Trade Council, dispute.

Still, there is little argument over the fact that enthusiasm for further trade expansion along the lines of the agreements pursued by both parties in recent years is at low ebb. A trio of bilateral trade deals with Colombia, Panama and South Korea, continue to idle in Congress. And the Doha Round of global trade talks sputtered to a halt this month when WTO Director General Pascal Lamy opted not to convene a last-ditch negotiating session in Geneva.

The U.S. recession — the economy is shrinking in the fourth quarter by an estimated 4% to 6% — provides a potentially receptive environment for anti-trade measures. "As time goes on and the jobless rate goes up everywhere, we will see a growing trend toward protectionism," says Sung Won Sohn, an economist at California State University.

The Doha Round’s failure also means countries will be free to impose tariffs that could shrink global trade volumes by $728 billion to $1.7 trillion, according to a new report by the International Food Policy Research Institute.

Countries typically apply lower tariffs than are permitted by the last global trade agreement, the Uruguay Round. They could legally increase them at any time.

Other arguments will come into play. Already one prominent U.S. economist, Dani Rodrik, has pointed out on his blog that the Obama administration’s planned economic stimulus would pack a greater punch if the U.S. raised import tariffs to make sure the money is spent here and not on goods from abroad.

Yikes! Rodrik is a renowned skeptic of free trade’s unalloyed benefits. But is he actually urging the next President to start a global trade war? Perhaps not…

But Rodrik also says a coordinated international effort to stimulate spending would be a better option than raising tariffs, which would invite retaliation by other countries and risk a 1930s-style trade war.

Michael Pettis gives a good overview of the dilemma and possible solutions:

Dani Rodrik is saying things that I have been implying in some of my pieces but have been very reluctant to say explicitly, largely because I don’t like the political implications for international trade.

Rodrik’s post, which is titled “Some unpleasant Keynesian arithmetic”, begins by wondering what the effect will be to the US economy of a fiscal stimulus. The answer depends on the Keynesian multiplier…

He estimates the multiplier to be 1.8 (in other words a $1 fiscal stimulus would increase US GDP by $1.8), and wonders if there were any way to increase it.

From Rodrik’s post: 

In fact you can. It is pretty easy to increase the multiplier; just raise import tariffs by enough so that the marginal propensity to import out of income is reduced substantially (to zero if you want the multiplier to go all the way to 2.8). Yes, yes, import protection is inefficient and not a very neighborly thing to do–but should we really care if the alternative is significantly lower growth and higher unemployment? More to the point, will Obama and his advisers care?

Being the open economy that it is, I fear that the U.S. will have to confront this dilemma sooner or later. In an environment where the dollar has already appreciated against the Euro and even more significantly against emerging market currencies, fiscal stimulus here will produce an even larger current account deficit. If American consumers decide to spend 40 cents of a dollar of additional income on cheap imports from China and other foreign countries, the multiplier will be a mere 1.3. How long will it take before politicians of all stripes cry foul over the leakage through the trade account and the “gift to foreigners” that this represents?

…The way out of this dilemma is to get the rest of the world to engage in fiscal expansion at the same time–so that the gift is returned. The good news here is that China is playing along and hopefully the Europeans will too (if they can convince Germans to get over their weird obsession with fiscal conservatism).

It’s a bit odd for Rodrik to call Germany’s fiscal conservatism "weird". Perhaps he doesn’t give give much credence to public choice or crowding out theories. Be that as it may, at least he sees a possible way out besides import tariffs.

However, Pettis indicates that "trade hardening" is afoot in Europe and perhaps in the U.S., and then draws attention to a very interesting feature of the Hawley-Smoot tariff that preceded the Great Depression (emphasis added):

The fact is that “rebalancing” trade (a code word for eliminating trade deficits, usually through mercantilist policies) is likely to be expansionary for deficit countries and contractionary for surplus countries, and certainly the experience of the world’s leading surplus country in the 1920s, the US, suggests that trade “rebalancing” was a disastrous experience. I have had a number of conversations with US and European officials in the past two weeks, and I get the impression that there is going to be a substantial hardening, especially in Europe, of positions on international trade, and I suspect that European officials are nowhere near as committed to keeping the market for global trade open as American officials are, but even American officials will turn against trade if popular discontent rises enough. The reason that I am very uncomfortable with the whole line of reasoning Dani Rodrik, I and others have been following is that I do firmly believe that active international trade is in the long-term interests of the world, and especially in the long-term interest of very poor countries like China…

I know I am going to be criticized for making this point, on the grounds that I am fanning the flames, but the fact is that the world doesn’t need me to make the connection – already it is starting to be widely discussed, and by next year it will be a major topic of debate. In fact if China does decide to engage in Smoot-Hawley- with-Chinese-characteristics, as the US did in its trade surplus days in 1930, and for which there is a great temptation in China, the results are a little too easy to predict.

Is such an outcome probable? It’s certainly within the realm of possibilities, and the historical parallels are interesting. E.E. Schattschneider’s Politics, Pressures and the Tariff details the political conditions and processes that brought about Hawley-Smoot, and it seems to us that such an event might be even more likely in a political economy like China’s. Does the world need to re
learn the trade lessons of the Great Depression? Leadership from the U.S. could make or break the issue. The following quote is from the People’s Daily by way of Pettis (emphasis added):

“China will continue to show good faith in the WTO, and we hope the US side does the same,” [China's Minister of Commerce] Chen [Deming] said…China is particularly concerned over four aspects of trade barriers and protectionism – free trade of textile products, expanding high-tech products trade, its market status, and the misuse of anti-dumping and countervailing measures, Chen said.

U.S. Congressional action on textiles is due in January. The stakes could be huge. If politicians here overreach, all bets are off.

An alternate path that we have previously outlined, and that we think presents the optimal solution, is for the world to engage in "rebalancing" through fiscal rather than monetary means, with "fiscal" referring to tax and other incentives, not just government spending. The object would be to incentivize greater saving and production in chronic deficit regions and greater consumption in chronic surplus regions. The latter aspect seems to be getting some attention in China. According to an article in Xinhua, also by way of Pettis:

The government Wednesday unveiled a raft of measures to encourage lending by financial institutions to infrastructure projects, small businesses and potential home and car buyers. Also, an extra credit volume of 100 billion yuan ($14.6 billion) will be provided to three policy banks this year to prop up economic growth amid the worsening global financial crisis.

An executive meeting of the State Council, or the Cabinet, presided over by Premier Wen Jiabao, also said steps will be taken to help financial institutions better ward off risks. Banks, securities firms and insurers should take coordinated action to play a bigger role in supporting economic growth and contributing to industrial restructuring, it said. In the face of the global financial crisis, it is imperative to implement a “pro-active fiscal policy” and “a moderately easy monetary policy”; and the financial sector should play a bigger role in economic development, the meeting said.

Financial sector deepening and growth of consumer finance in China are key elements to global  rebalancing. Shifting incentives towards saving and production in the U.S. are also key, but they don’t appear to be getting as much attention, if any. And if these types of measures do not get enough emphasis, then currency manipulation could take precedence, a point which Pettis closed on regarding possible policy directions for the Chinese RMB. To that we would add our frequent refrain that, as issuer of the global reserve currency, the Fed must not act as though its policies affect only the U.S. economy and price level. It’s also important to note that USD stability (in real terms) is a very effective means for stimulating greater domestic savings, which makes the choice of tax, fiscal, and regulatory measures by the next Administration and Congress all the more critical.

URLs:

http://www.usatoday.com/money/economy/2008-12-28-global-import-export-trade-slump_N.htm 

http://www.nytimes.com/2008/12/22/world/europe/22russia.html 

http://www.rgemonitor.com/asia-monitor/254688/dani_rodrik_is_letting_the_cat_out_of_the_bag 

http://rodrik.typepad.com/dani_rodriks_weblog/2008/12/some-unpleasant-keynesian-arithmetic.html