The mercantilist threat to global rebalancing

The mercantilist threat to global rebalancing

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Bill Mitchell has been doing a series of posts on the circumstances leading to the UK's request for aid from the IMF in 1976. They give a fascinating insight into the economics of a time when trade balance and the international exchange value of the currency were the most important drivers of national economic policy. Since the great monetarist revolution of 1979 we have largely forgotten about this: nowadays it is fiscal, not trade, balance that concerns us, and we happily devalue our currencies and force down labour costs in search of elusive export-led growth. I believe we are chasing a dream.

For the last 40 years the world has been gradually rebalancing, as the West abandoned empire and colonialism in favour of free trade. Dismantling barriers to trade and freeing up world markets has not been easy, and it is fair to say that many Western countries have been more interested in ensuring that developing countries open their markets to imports than removing the tariffs and subsidies that protect their own precious industries. But the growth of supra-national companies, supported by (largely) free movement of capital around the world, has transformed the world economy. And from the point of view of the millions in developing nations who enjoy a standard of living of which their grandparents could only dream, this transformation has unquestionably been positive.

However, the process is not without its problems. There are still pockets of poverty in India and China, particularly in the rural areas that have suffered huge outflows of people as industrialisation encourages the growth of cities. Most countries have problems with the equitable distribution of resources: although developing nations are getting richer, a disproportionate amount of those riches go to a small number of powerful people, while poverty at the lowest level remains unrelieved. Widening inequality within countries is also a feature of Western nations - in fact it appears to be a global secular trend, although the recession of 2009 temporarily reversed it in some countries.

Rapid industrialisation of emerging markets has also placed pressure on global resources, notably energy sources. And there is a growing problem of pollution in countries such as China. There are also concerns about the effect on the climate of the huge increase in CO2 emissions from countries that are industrialising rapidly. All of these are legitimate worries. But they are not in my view a reason to derail the process of global rebalancing.

Global rebalancing is difficult for many people in Western countries to accept, because it threatens their standard of living. In the absence of trade restrictions and capital controls, capital moves a lot more easily than labour does. Even where there are no barriers to the movement of people - in the European Union, for example - labour is "sticky" because of family and cultural ties. And in most of the world there are significant barriers to labour migration: most countries are happy to let people leave but not so happy about letting new people in, because of fears about pressure on national infrastructure, finances and jobs. That means that wage imbalances between countries cannot resolve themselves through migration, so must resolve either by changes in average wage levels in both countries or through currency revaluation. Excess labour (unemployment/underemployment) pushes down wages: competition for (relatively) scarce labour pushes them up. If currencies float freely against each other then wage differences should be absorbed in the exchange rate: but when currencies are pegged to each other in some way - for example, the renminbi's soft peg to the US dollar - the differences show up as falling wages in the excess labour country and rising wages in the labour deficit country. This might go some way towards explaining stubbornly high unemployment and declining median wage in the US, and rising wages in China. If so, then we would expect that eventually wages would stabilise in both countries. The problem of course is that whereas this process is good for Chinese, it is painful for Americans. So it is hardly surprising that calls to stop it by imposing trade barriers, forcing revaluation of the Chinese currency and interfering with the free movement of capital tend to come from Americans. 

In fact there are increasing calls from Western nations for globalisation to be ended because of its supposedly terrible effects. Western environmentalists call for the ending of international trade, apparently on environmental grounds but in reality to protect the economies of the rich Western nations who fund their work. Organisations such as the UK's New Economics Foundation call for capital and/or exchange controls to protect domestic jobs and wages. Vested interests in the US push through restriction of imports from China under the guise of "national security". Politicians in the EU bizarrely use anti-protectionist legislation to protect industries that are being undercut by cheaper products from other countries. It is all too easy to view cheap exports from other countries as an attack, and respond by putting up protectionist barriers. But this is mercantilist thinking. From a national perspective it appears to make sense, but if it leads to tit-for-tat protectionist moves, in the end neither country benefits and the world as a whole is poorer from the loss of trade. Trade wars, like all wars, are destructive.

However, at the moment the yuan's international value is rising relative to the US dollar. As David Ricardo said, when capital can move freely the cost of transportation & managing supply chains become the main disincentive to relocating production:

" ... if capital freely flowed towards those countries where it could be most profitably employed, there could be no difference in the rate of profit, and no other difference in the real or labour price of commodities, than the additional quantity of labor required to convey them to the various markets where they were to be sold."

So as Chinese wages and US wages come closer in value both because of nominal wage changes and because of the rising value of the yuan, and transportation costs rise due to increasing fuel scarcity and the need to minimise climate impacts, we should see US production coming home. But not for US workers. For robots. We would replace offshoring with automation. After all, the only reason that automation has not happened as quickly as many people predicted is that labour costs in developing countries have been lower than the costs of automation. Once that is no longer the case, there would be no reason not to automate. And increasing automation in the West would eventually bring about a natural end to global rebalancing as production costs fall - although equitable distribution of resources would then become the major problem. The temptation for China, of course, would be to manipulate its currency and/or use capital controls to support its exporters and retain production offshored from the West: but eventually it too would see its human workers replaced with robots in production and many service industries. The transformation of work will eventually be a global phenomenon. 

Where does this leave international trade? The present pattern of world trade is highly unbalanced: developing countries run large trade surpluses and most Western nations (with the notable exception of Germany) sizeable trade deficits. It could be argued that the developing nations have bootstrapped their growth from the willingness of people in Western nations to consume more than they produce and spend beyond their means, funding the difference with debt. But as production costs equalise and product prices both in developing nations AND in developed nations fall, the present large trade imbalances should start to disappear and balanced trade patterns be restored. This is bad news for countries whose prosperity depends on persistent trade surpluses to balance shortage of domestic demand. The fact is that when the world starts moving towards a more balanced trade model, countries that are very reliant on exports may suffer because of depressed incomes and lack of domestic consumption. In its 2012 report (Section III, pp 24-5) BIS noted this risk in relation to both China and - especially - Germany. 

The brutal trade rebalancing that is occurring in the Eurozone at the moment is a useful indicator of what may be to come on the global stage. Mercantilism features in the Eurozone too, but in a different form from the protectionism and trade wars that I discussed above. Although Germany is fiercely opposed to overt protectionism, Germany's economic model is neo-colonialist - selling products to poorer satellites using money that its banks lend to them, tying them in financially and giving Germany power to dictate terms to satellites that have become financially dependent upon it. The flawed Euro model has greatly assisted in this: the single currency makes German production relatively cheaper and satellites' production relatively more expensive than it should be, destroying satellites' competitiveness and encouraging import dependence and indebtedness. But now that the deep recession in the South of Europe means that some of those satellites can no longer afford its products, Germany is expanding exports outside its satellite zone and using the satellites as a source of cheap labour - hence Chancellor Merkel's encouragement of migration. To what extent this is deliberate policy is unclear. But the effect is impoverishment of the satellites and enrichment of the colonial power in much the same manner as happened in the British Empire - which was similarly founded on "trade" (highly skewed in Britain's favour and backed up by force). As Michael Pettis says in his book "The Great Rebalancing", Germany's pursuit of its own prosperity at the expense of its neighbours must change or there will be a real risk of disorderly breakup. 

The German idea that all countries can be net exporters just like Germany if only they would screw down domestic spending enough may work for the Eurozone if it is a net exporter to the rest of the world. But as we don't (yet) trade with Mars, it is sheer nonsense in a global context. Imports and exports around the globe net to zero. If one country is a net exporter, others must be net importers: if this remains the case over a long period of time, net importers inevitably become highly indebted, leading to loss of financial independence, destruction of domestic production capability and - eventually - declining trade as imports become unaffordable. The large trade imbalances we have at present are historically anomalous and in the long term unsustainable. 

Which brings me back to where we started. Balance of trade DOES matter, and we should be paying far more attention to it. As growth slows in developing nations, there should be a gradual return to balanced trade for most countries. And the IMF should return to its real job, which is helping countries deal with balance of trade problems - not colluding in the imposition of destructive fiscal austerity on countries damaged by flawed political constructions, dysfunctional financial institutions and the beggar-my-neighbour policies of their main trading partners.

Mercantilism - the chasing of export advantage at the expense of others - is fundamentally destructive of world trade, and even of world peace: mercantilist trading practices have in the past been a major cause of wars. There may be a case for using selective subsidies and trade tariffs to protect infant industries, and for using capital and exchange controls to defend against destabilising flows of capital. But if the world as a whole starts putting up significant barriers to trade, the global rebalancing that is bringing prosperity to millions will be replaced with global misery.


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Related reading:

Does Mercantilism Work? - Noahpinion 

Case study: British IMF loan 1976 part 6 - Bill Mitchell (links to parts 1-5 at start of post, part 7 to follow)

Why we need a new economic strategy - NEF  (capital controls are a core part of NEF's proposal for a Green New Deal)

The changing nature of work - Frances Coppola

Austerity and the Eurozone - Coppola Comment

The Great Rebalancing - Michael Pettis (book - link is to Amazon)


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