Diatribes of Jay

This is a blog of essays on public policy. It shuns ideology and applies facts, logic and math to economic, social and political problems. It has a subject-matter index, a list of recent posts, and permalinks at the ends of posts. Comments are moderated and may take time to appear. Note: Profile updated 4/7/12

17 November 2009

Trade Policy for One: Saying “No” to Modern Mercantilism

1. Sweet memories of mercantilism
2. The postwar global economic system
3. China’s modern mercantilism
4. The fateful embrace
5. What to do: trade policy for one

1. Sweet memories of mercantilism. Remember “mercantilism”? That was a nineteenth-century economic policy designed to keep the strong on top and the weak down. It helped rapidly industrializing nations like England dominate the markets for both manufactured goods and the raw materials to make them.

The policy was simple. Industrializing nations themselves became the chief markets for manufactured goods for two reasons. First, the wealth brought by their own manufacturing created markets for the goods it made. Second, industries needed more machines to build and maintain their machines and to transport raw materials and finished products.

To enhance and maintain these natural market advantages, industrializers imposed tariffs on imported foreign manufactures. The tariffs added a price advantage (over foreign makers’ goods) to the natural advantages of being first and market size. They inhibited market entry by competitors in industrializing nations.

The barriers that tariffs raised let only firms in dominant nations achieve economies of scale. Those economies in turn allowed dominant firms to lower prices further, gain more sales, and accumulate the capital needed for continued innovation. The result—for many decades—was a global market in which the first nation or nations to industrialize could dominate wide sectors of manufacturing not only inside their own borders, but worldwide.

As mercantilism spread, it affected markets for raw materials. Because their manufactures sold well, industrialized nations had more cash available to afford raw materials. Their cash hordes allowed them to outbid others globally. Where higher prices didn’t work, “gunboat diplomacy” did. By virtue of their earlier industrialization, leading nations had more powerful military forces able to project military power over longer distances. The British Navy was a prime example.

So mercantilist nations plundered the raw materials of developing nations in an orgy of colonization. On occasion, they fought each other over the spoils.

2. The postwar global economic system. That was the scene at the dawn of the twentieth century. Two rising powers—Germany and Japan—came late to the colonization party. Germany had another disadvantage: it was mostly landlocked as well. Except for Germany’s coal, neither nation had huge stores of natural resources. Both lacked access to the fuel of choice for the coming century: oil. Both didn’t like the rest of the world keeping them down with tariffs, military control over raw materials, and economic manipulation. The result was a half-century-long bloodbath and the most destructive war in human history.

What has kept the peace for the last sixty years is not just the Bomb and the threat of mutual annihilation. The powers that won World War II began to understand that economics had played a key part in starting it. So they set out to create a global economic system in which everyone could trade on a level playing field. That effort began in 1945 with the Bretton-Woods agreement fixing monetary exchange rates, which kept the gold standard. It accelerated with the GATT (General Agreement on Tariffs and Trade) system, abandonment of the gold standard in 1971, and eventually the WTO.

Building that level playing field has taken over half a century and is still a work in progress. Enlightened, long-term self-interest had to fight short-term stupidity, greed and nationalism every step of the way. But we now have a rational global trading system in which vital raw materials like oil, iron, copper and soybeans trade globally on a mostly free market. Manufactured exports and imports have to overcome lower (and more even) tariffs than ever before. And we are working on leveling the playing field for trade in service and agricultural products, which are what the failed Doha Round of trade talks was all about.

Were these huge changes in policy altruism? No. They did produce the greatest transfer of wealth and welfare from dominant to rising nations in human history. But the transfer was not a gift; it was a product of enlightened self-interest. The powers that were dimly understood that short-term selfishness like mercantilism would only lead to economic imbalances and other wars, which in the nuclear age means sui-genocide. They also realized (a bit late) that cooperation beats fighting—that a truly global market speeds commerce, trade and innovation in science and technology and ultimately benefits our entire species.

3. China’s modern mercantilism. But now one rising power—China—has found a new form of mercantilism that seems to be working well for it. The new form is a subtle one: currency manipulation. By keeping the renminbi low and the dollar relatively high, China maintains a cost advantage for its exports over competing exports from abroad. Thus it expands its industrial base and maintains full employment.

That cost advantage of a low currency gives China all the advantages that mercantilism gave leading nineteenth-century economic powers. It lets Chinese industry produce more, achieve greater economies of scale, and accumulate capital for expansion and innovation. It attracts foreign manufacturers to China, adding to the natural advantage of low wages that its relatively lower standards of living allow. And it allows China to command a dominant position in global raw-materials markets by virtue of the size and strength of its internal markets, the strength of its manufacturing, its huge hoard of savings, and the size of its buys.

China’s new mercantilism is by no means as crude as the old. The old mercantilism was like pointed spears in the ground, excluding imports. The new mercantilism is more like ju-jitsu; it uses the desires and momentum of economic partners and rivals to their disadvantage. In order to keep its renminbi low, China buys lots of dollars, mostly through our debt offerings.

4. The fateful embrace. China’s currency manipulation has short-term advantages for us, too. Its massive buying of our debt helps finance our deficit and keep interest rates here at home low. China’s debt financing helped make our economic stimulus possible and ward off a second Great Depression.

But there are two flaws in this so far pretty picture. First, the global macroeconomic imbalances exacerbated the recent crisis, reducing employment in both countries as American consumers retrenched. Second, in the long run this unbalanced system would completely hollow out American manufacturing—a trend that is politically unacceptable and (if continued) likely to produce serious conflict.

So as leaders of both China and the U.S. have noted, the present system is unsustainable. The problem is how to wind it down. If China were to sell all its T-bills suddenly, interest rates here at home would skyrocket, choking off our weak economic recovery. Unemployment, which is now approaching stability, would explode. The feared (but so far avoided) second Great Depression might ensue.

None of those things would be in China’s interest. For we are still the greatest market for China’s manufactures, and our multinational corporations are woven into the fabric of China’s manufacturing economy. Anyway, a fall in the dollar would directly reduce the immediate value of China’s hard-earned two trillion dollars in foreign reserves.

Not only that. China owes much of its manufacturing advantage to American technology. I learned this when I looked at the bottom of my wife’s Mac Mini—the cheapest computer in which Apple offers its superb OS X operating system.

Steve Jobs and OS X are as American as Apple pie. But the legend on the bottom says, “Designed by Apple in California. Assembled in China.”

American technology needs low-cost Chinese manufacturing to succeed. China needs American technology (to maintain its manufacturing predominance) and American consumers (to maintain its markets). Both countries need currency stability—the Chinese to avoid a precipitous drop in exports and exploding unemployment, and we to avoid the same result from interest-rate increases, exploding deficits, and consequent economic collapse.

So whether you call it a bear hug or a death grip, we and China are in an inescapable mutual embrace. Sudden moves on either side might be catastrophic. And war is out of the question: it would destroy a half-century of global economic progress and (if nuclear) likely extinguish our species as well. So what can we do?

5. What to do: trade policy for one.Whatever we do must take effect gradually. Sharp and sudden changes in government policy are probably not going to happen anytime soon, and anyway they would be risky and unwise.

The last thing either nation wants to do is excite the kind of unthinking nationalism that motivated the last century’s awful bloodbaths. History is too replete with misunderstandings and miscalculations to endorse sudden shifts in government policy in either country, or demagogic appeals that promote them. Blowhards like Lou Dobbs and Rush Limbaugh are humanity’s worst enemies.

But government need not do everything. Consumers and private businesses are another resource. Both sides can change the equation, without any apparent change in government policy, by accumulating “trade policies of one,” i.e., individual decisions of consumers and businesses.

There is irony in this suggestion. For millennia China has had a mass culture unacquainted with personal freedom and consumer choice. It recently emerged from the faceless anonymity of Communism. Yet already it is exhorting individual consumers in its vast population to do their parts by buying more and saving less. Coupled with domestic economic policies making saving less attractive, those exhortations are starting to take effect.

But what about us? Our economists rely on our consumers to drive global recovery, constantly citing the statistic that consumers account for 70% of our GDP. But our consumers are trained like Pavlov’s dogs in classical economics. They salivate reliably on buying everything at the lowest price, sometimes heedless of quality. Invariably they are heedless of the effect of their collective buying decisions on macroeconomic conditions.

Suppose our consumers started to take macroeconomics into account in their purchases. Suppose they started to buy American again.

I’m not talking about consumers at the bottom—the laid off, foreclosed, or those just scraping by. They need to save every penny they can. I’m talking about those of us still in the comfortable middle class, especially those who managed to come through this crisis relatively unscathed.

All we have to do is turn those products over, look at the labels and—when the decision is a close one—buy the one made in America, even if it costs a bit more. The extra pennies we spend on price will come back to us many times in savings on taxes for stimulus, unemployment insurance, and other social “safety nets.” And whatever extra we spend on domestic manufactures will have a “multiplier effect” as American employment increases and manufacturing revives.

Let’s take an example. This year my wife and I bought two Hyundais. We did so after doing exhaustive on-line research in the spring and test-driving in the late spring and early summer. Until this fall, when Consumer Reports’ analysis of new cars came out, we had no idea how much Ford and GM had improved their cars’ gas mileage and quality. If we had, we might have bought Chevies or Fords. As we Boomers used to say, “Bummer!”

But I have not given up on the Chevy Volt. Over two years ago, I promised on this blog to buy one if its price came in under $ 35,000. Now it looks as if the price will be $40,000, but I renew that pledge. Early next year—the year the Volt is supposed to debut—I’ll go down to a local Chevy dealer, sign up, and put down a deposit. What’s an extra $5,000 to own the first modern electric car, a solution to most of our energy troubles, and the first radical innovation in American cars in half a century?

The two Hyundais were just interim solutions. Our buying them reflected an economic reality that should provoke optimism: people can’t put off buying new cars forever. One replaced a jalopy that was very, very old.

From those who have much, much is expected. The lopsided economic system that our debt binge and foreign shopping spree has forged is going to stop one way or the other. Either it will stop when our currency crashes, inflation explodes and we can no longer buy foreign. Or it can stop, slowly, gradually (and much more gently) if we who can afford to do so tilt our individual buying decisions every so slightly in favor of things made mostly by our own fellow citizens.

I know, I know. These days it’s often hard to tell what’s really American. That Apple Mini “assembled” in China, for example, sports not just California design. It also has an Intel “brain,” and probably many other parts designed and made in America. But its decisive feature is the operating system—one so much better than its competitor that you’ve got no choice but to buy the Mac, wherever it may be made.

Not all products are like that. A car is a car. If it has the comfort features you need, runs smoothly and well, gets good gas mileage, is well made (with doors that don’t clunk), looks good, and is likely to be reliable, it’s a good buy. After decades of industrial stagnation and mismanagement here, American icons like Ford and GM finally are making cars like that, and their prices are attractive. It’s time to buy them. It’s also time to buy other big things, like appliances and building materials, that we Americans still make well.

Business should make the same decisions. If price and quality are decisive, by all means buy foreign. But if the decision is a close one, tilt the scales in favor of domestic manufactures. Buy GE’s windmills rather than Vestas.’ Buy GE’s jet engines or gas turbines, rather than Rolls Royce’s. Wait for Boeing’s super-efficient Dreamliner, rather than buying Airbus’ monstrous A380.

Chinese consumers and businesses can help similarly. When facing a decision whether to buy now or save, they should tilt the scales in favor of spending. When deciding whether to pick an American or other foreign product, they should tilt the scales in favor of the American one. Why? Because China is locked in a permanent economic embrace with the United States, which no one wants to become a death grip. Chinese consumers and businesses need to help their nation’s most important economic partner far more than they need, for example, to help Brazil, Germany, Japan or Singapore.

This “trade policy for one” need not be a permanent feature of the global economic landscape. We have some hideous imbalances in our global economic system now, and we need to fix them gradually but soon. What better way than millions of informed individual decisions: Adam Smith’s “invisible hand”? Consumers and businesses will know when the global economy is back in balance; then they can alter their own individual policies correspondingly, gradually and at their own pace. All can go back to buying on price alone again, if they wish.

If governments get too involved, nationalism and its co-conspirator protectionism will rear their ugly heads. There will be risks of miscalculation, overreach and unanticipated consequences, which might exacerbate international tensions and take decades to unwind. If consumers and businesses in both countries act intelligently, with enlightened, long-term self interest, we might restore balance organically and gradually, leaving governments to handle the really hard stuff, like bringing Iran and North Korea into line.

Let’s each introduce our own intelligent trade policy, one by one, in our daily lives. The Internet can help.


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