The threat from protectionism
|Our Correspondent||Oct 14, 2008|
Adapted from “Trade Myths: Globalization and the Trade Balance Fallacy,” Inkstone Books, Hong Kong, 100 pp, HK$119, or from Amazon Books US$11.70, or Paddyfield Hong Kong, HK$133.
In today’s instant and interlinked age of the internet, protectionist politicians still insist on applying the thinking and measurement of trade balances that was developed 500 years ago in Italy. This software laid the intellectual foundation of mercantilism, which ruled from overtly 1500 to about 1750. However, even now – over 500 years later - mercantilism’s software is firmly embedded in most politicians’ thinking on trade, trade flows and thus trade policy. But mercantilism is an iron cage enclosing protectionism.
Politicians using this outdated and dangerous approach ignore the critical role played by multinational corporations in today’s globalization. This is toxic.
On the top line, protectionist politicians garner votes cheaply by blaming the foreigner for what they describe as unfair imports;
However, in the foggy middle, protectionist politicians harness this insidious blame game in order to deflect from their very own policy shortcomings – ones that have led to crippling tax regimes and terrible education – the real reasons for sluggish job-creation in the developed world, and
The bottom line is that these 15th century protectionists increasingly are antagonizing the leadership of those countries hosting MNCs - particularly in emerging markets, the one remaining area for solid profits growth. Expect them to retaliate and make the life difficult for MNCs operating there. Already we are seeing examples of how, for instance, protectionists in America are antagonizing China’s politician-bosses so much that they in turn are making life increasingly difficult for US MNCs operating there.
Protectionist politicians increasingly threaten the profitability of their very own, American MNCs and thus
The 23 million jobs they create in America,
The $341 billion worth of investments that they have ploughed into America, and
The 25 percent of US gross domestic product that they generate.
How do these politicians threaten the profitability of one of their key constituents and thus financial backers, America’s MNCs? Increasingly, parent MNCs see that the future’s money fountains for them are their overseas operations in emerging markets. But once they have established such foreign affiliates, their operations are sitting ducks that can be helped or hindered by the host country in which they are operating. For one thing, their legal systems offer little recourse. Besides, the politician-bosses of these emerging markets have their own agendas. So, if America’s protectionist politicians irk these politician-bosses too much, they will retaliate, in turn, by taking-out their anger on the foreign affiliate. A simple example: American politicians want China to revalue the renminbi.
So local/national party bosses single out the American MNCs operating in China and make their lives more difficult. The only winners are the local politician-bosses, and, of course, the local operations of other countries’ MNCs whose politicians have not irked the local powers: these MNCs now at little cost get to fill the vacuum created by the demise of the American MNC’s operation.
This, in turn, reduces the global profits of the parent MNC, thus angering all if its employees, financiers and shareholders.
History’s Unlearned Lessons
In addition to one particular MNC being threatened, on a broader, political scale, the danger is that the resulting protectionist wave will be felt in hostile international relations and thus in more terrorism. It was just this protectionist fervor that radicalized the non-democratic capitalist powers, Japan and Germany, in the 1930s. There are parallels today in the authoritarian capitalist states of China and Russia. Already, protectionist sentiment is rising yet again in America, especially among the poorly educated workforce. With protectionist politicians threatening the overseas operations of their own MNCs, prosperity has to decline in the host countries. Less prosperity means more fertile ground for terrorists. This is the shape of things to come.
Wake Up Call for Capitol Hill
With election momentum mounting, now is the time for decision-makers particularly in Washington and in Brussels , to wake up and realise the perils of allowing protectionist politicians once again to brainwash voters with their barrage of trade myths – yes myths – about what drives America’s and Europe’s economies. In this book I offer an iconoclastic view: questioning these major fables and showing how insidiously irrelevant they have become in today’s globalized world.
Here are the myths that protectionist politicians would have you believe:
Myth One: Imports kill Jobs
Myth Two: Exchange Rates Drive Trade
Myth Three: A Trade Balance Is a National Matter
Myth Four: A Trade Deficit Is Bad
Myth Five: Foreigners Finance America
These have been repeated so often over the centuries that they have acquired the ring of truth, but nothing could be more dishonest and dangerous.
Politicians peddle and perpetuate these myths because they attract votes – like light bulbs attract moths. Each insidious myth taps into voters’ fears about their job security. So, the protectionist politician promises to protect jobs by banning “unfair imports” gets Pavlovian responses, particularly of the poorly-educated: they vote for him/her.
Imports Kill Jobs - So let’s protect ourselves against unfair imports.
When it comes to getting elected, politicians play the blame game with jobless figures. One way to deflect criticism is to accuse “unfair” imports of killing domestic jobs. This conveniently ignores the many real reasons for unemployment, such as inadequate education and under-qualified workers, heavy taxes, onerous government policies and poor corporate strategy.
Exchange Rates Drive Trade - So let’s make other countries devalue their currencies.
This one allows politicians to deflect attention from their own unemployment-creating policies by blaming the low exchange rate of a country that is running a large trade surplus with America. The logic here is that if only the exchange rate of that country were stronger, America would have no deficit. It’s all very well to hector other nations to lower their rates, but these protectionist politicians, by definition, are devaluing the greenback. As we already see, this foments higher imported inflation and thus higher interest rates; besides, foreigners want to shed their increasingly devalued dollar-based assets.
Ultimately, telling others to revalue threatens American jobs. From 1985 to 2008 the US dollar fell by about half in terms of its trade-weighted exchange rate with major trading partners, but America’s trade deficit expanded nearly seven-fold Meanwhile, Germany and Japan have trade surpluses despite rising currencies…
A Trade Balance is a National Matter - So imports hurt us.
Armed with the twin myths that imports kill jobs and that “undervalued” foreign currencies cause America’s trade deficit, it’s a short step for politicians to depict the deficit as a threat to America. This national perspective is that Fortress America is under threat, leading to the emotive notion that foreigners, usually Asians, are about to launch an economic 9/11. The reality is that the bulk of America’s trade deficit is not about bad foreigners banning imports from America, nor is it about Americans buying unfair imports from abroad. Instead today’s globalized reality is that America’s trade deficit mirrors the fortunes of her very own MNCs’ success at tailor-making and thus selling goods directly in the overseas markets in which they operate. MNCs obviate the need for many exports. Laconically put, if IBM is produces tailor-made computers in Japan, then why need the Japanese import IBM computers from America?
America’s Trade Deficit is Bad – Which means that Americans are living beyond their means
Viewing trade balances as national property enables many US politicians to label the country’s trade deficit as bad – something that must be done away way with. By this definition, anyone with a deficit is living beyond their means, with all the Puritanical disapproval that phrase implies. The whole argument stems from Mercantilist thinking of the 18th century, when companies operated within their national borders and huge gold reserves were desirable for financing wars. But this is 2008: which firm is so virtuous or stupid that it never borrows? Try telling that to America’s gigantic financial firms!
The intellectual backup to this sophistry is the “savings investment balance”, whereby a country’s trade deficit is funded by savings. This must be challenged as the emotional heart of the outdated Mercantilist mantra: “Our trade deficit is bad, because we live beyond our means – and thus have no savings.” But this disingenuous view perniciously avoids working with today’s reality: America’s trade deficit is due to the outstanding overseas successes of our multinationals’ overseas operations.
Foreigners Finance America’s Trade Deficit - the foreigner not only has given us a deficit, but holds the Sword of Damocles over us by funding it.
Another consequence of the mercantilist mindset is that because Americans don’t save, their trade deficit only can be financed by foreigners. This creates an emotional mindset of vulnerability, allowing protectionist politicians insidiously to blame the foreigner for America’s ills. In reality, Americans themselves – such as the foreign subsidiaries of US multinationals - own huge portions of America’s federal government debt offshore. So which “foreigner” holds U.S. government debt? Anyway, what would the foreigner gain by yanking their investments out of America? Selling them at a lower price? Finally, where could the foreigner re-invest these funds on the same scale? Every school child knows that America not only has the most sophisticated financial markets; moreover, hers are larger than all the other major capital markets combined.
This book is trenchant, iconoclastic – and deliberately 100 pages long, making it a quick read. Globalization truly has left trade balances behind and when studying trade flows and thus trade policy, policymakers are ignoring the increasingly vital role of multinational corporations at their peril. Globalization is changing paradigms by the day, so we urgently need to challenge conventional myths, or lose the plot. when protectionist politicians irk the politician-bosses of those countries hosting profitable MNC operations, the parent MNC’s very existence is threatened. So why do such MNCs keep financing the pernicious sophistry of such protectionist politicians?
While the immediate aim is to reach decision makers, particularly those in America, Europe, Japan and China, the broader objective is to move thinking away from geographical trade balances and instead towards global trade balances. Most of all my main purpose, as Alan Blinder once said, is to get as many smart people as possible thinking creatively about the problem. So read this book.
Born in Namibia and raised in America, Germany and England, Enzio von Pfeil studied under Friedich von Hayek and got his Ph.D. in economics, then worked for the world’s three leading banks of their day. Formerly chief regional economist for leading London-based investment banks in Hong Kong, von Pfeil is now an independent investment adviser and a regular contributor to Bloomberg Television UK, Bloomberg Television Deutschland, and to CNBC Asia. His investment advice is constantly updated at www.EconomicClock.com .