Every few months, without fail, somebody asks me why, if the protectionism I advocate between the U.S. and the rest of the world is rational, isn't it rational to have tariffs between the various states of the U.S.? And since it clearly doesn't make any sense to have tariffs on trade between, say, California and Oregon, it follows that nations shouldn't practice economic protectionism either.
Sounds good. In fact, some people proffer this argument as if it, on its own, settled all questions in the complex field of trade economics.
Sometimes, the above argument is presented more radically. People argue that it's irrational (or even evil) to care about national economic well-being at all, because globalization has rendered nations economically irrelevant (or outdated constructs that do nothing useful and just start wars).
Therefore, it's well-worth reviewing why it's a normal and reasonable thing for nations to exist as economic units, and for us to care about their well-being. We should neither expect nor want them to go away. And this is a matter of economics, not politics -- let alone nationalist ideology, though you can believe in that (or not) if you want.
The recent debt crisis in Europe illuminated in stark fashion some of the key facts that make national economies still relevant and economic borders still valuable.
In case the reader isn't familiar with the story, what basically happened was that, when the euro currency was created in 1999, this gave all the governments of Europe roughly the same ability to borrow money. Granted, there were still some minor differences, but nothing like the differences (measured by the different interest rates on the bonds issued by different nations) that prevailed before. Previously, when the government of Greece, for example, wanted to borrow money, it either had to borrow in drachmas (and was thus limited by its own national savings rate) or borrow in a foreign currency like dollars or deutschemarks and take the risk that exchange rates would move against it. So borrowing was constrained (imperfectly) along the lines of ability to repay.
Then came the euro, which erased all those squiggly lines that used to divide up the European currency map and gave American tourists such a fascinating variety of pictures of dead politicians to bring home at the end of their vacations. And what happened? The result was a borrowing binge in the less-creditworthy nations, which had suddenly been granted access to money on (close to) the same terms as financially-prudent export powerhouses like Germany.
Uh oh.
In some countries, like Greece, this resulted in excessive government borrowing. In others, like Spain, it resulted in a real-estate bubble as cheap mortgage credit (whose price was calibrated off of the rate the government can borrow at) flooded the country.
Then, of course, there was a bust in all these countries. Like our own 2008 financial crisis, it generated a lot of secondary turbulence (and considerably more street riots) and exposed a lot of the previous decade's apparent prosperity for a sham built on a house of cards called debt.
The lesson? Europe would probably have been better off keeping a lot of its old national currencies. These don't stop international flows of money, of course, but they do impose a cost, in the form of exchange rates, when you move wealth from one country to another. They are a meaningful but not prohibitive barrier.
The lesson here is that treating all national economies like they are the same -- by dropping the currency barrier -- doesn't work when they are not the same. An absence of economic barriers presumes economic similarity on both sides of the barrier. The barrier doesn't have to (indeed shouldn't) be absolute--you can exchange one currency for another at a bank -- but it is still a meaningful constraint. It makes things you shouldn't do expensive.
The currencies of different nations should have different values, to reflect the fact that the economies whose output makes these currencies worth something are meaningfully different. They have different productivity levels, different accumulated wealth, different propensities to save rather than consume, different labor laws and thus personal behavior, and so on. Treating these different national economies like they are the same just invites economically irrational behavior -- like borrowing money you can't afford to repay.
Removing the currency barrier between disparate national economies also deprives them of the ability to fix certain problems by adjusting their currency value so that it accurately reflects their economic condition. Having different currencies functions something like a universal joint in engineering: it transmits torque, but it's also flexible. As economist Paul Krugman recently explained it:
Imagine that you're a country that, like Spain today, recently saw wages and prices driven up by a housing boom, which then went bust. Now you need to get those costs back down. But getting wages and prices to fall is tough: nobody wants to be the first to take a pay cut, especially without some assurance that prices will come down, too. Two years of intense suffering have brought Irish wages down to some extent, although Spain and Greece have barely begun the process. It's a nasty affair, and as we'll see later, cutting wages when you're awash in debt creates new problems. If you still have your own currency, however, you wouldn't have to go through the protracted pain of cutting wages: you could just devalue your currency -- reduce its value in terms of other currencies -- and you would effect a de facto wage cut... In the current crisis, it took Ireland two years of severe unemployment to achieve about a 5 percent reduction in average wages. But in 1993 a devaluation of the Irish punt brought an instant 10 percent reduction in Irish wages measured in German currency.
But you need the currency barrier between nations for it all to work. At bottom, this means accepting the fact that national economies are different, and function best when this differentness is recognized, not denied.
The creation of the euro was predicated on the idea that having a common currency would of itself cause these nations' economies to become similar. On paper, this is, of course, perfectly logical, in the sense that if the European economies had converged to similarity, these problems would not have occurred. But they didn't. National economies are not paper abstractions that can be manipulated at will. The fact that Germany, for example, has the economy it has, and Greece the economy it has, is rooted in decades (if not centuries) of economic history, different political systems, different cultures, and other things that just don't go away at the stroke of a pen. Even if you leave out all the political and cultural factors, national economies are still very different simply qua economies: they have different skills, tend to specialize and excel in different industries, have billions of dollars committed to different industries, have their particular drawbacks and flaws, etc. For example, as Michael Porter of Harvard Business School explains it:
Competitive advantage is created and sustained through a highly localized process. Differences in national economic structures, values, cultures, institutions, and histories contribute profoundly to competitive success. The role of the home nation seems to be as strong as or stronger than ever. While globalization of competition might appear to make the nation less important, instead it seems to make it more so.
So, contrary to the endlessly repeated myth of a world converging on one big economic sameness, economic diversity (a concept that is poorly understood compared to, say, ethnic or cultural diversity) is a fact of life -- and almost certain to remain so. Economic policies that assume a homogeneous world, whether they take the shape of a pan-European currency or global free trade, are an attempt to defy this basic fact. And the cost of failure runs into the trillions.
What's the connection to trade? It is that free trade is like having a shared currency: It makes it impossible to draw the distinctions that sometimes need to be drawn between different economies. This isn't a matter of cutting off all trade, any more than having separate currencies means you can't exchange one currency for another. But it does mean there should be trade barriers that reflect the real (and quite legitimate) differences between national economies.
Let's start with an example that's easy to understand, one quite familiar from complaints by the unions and the environmental movement: What if environmental or worker-safety standards are higher in one nation than in another? Then having free trade is obviously an open temptation to just move production from the former to the latter. It may not literally be a race to the bottom, i.e. fast and reaching the absolute worst standard, but it sure produces pressure in that direction.
And this is just the tip of the iceberg when it comes to economic differences. What if nations differ not in their environmental standards, but in, say, their propensity to save vs. consume their income? For example, the fact that the U.S. currently practices free trade means that, because we have a high preference for immediate consumption as opposed to savings, we are gradually selling off our country and going into debt, thanks to the trade deficit. This is the well-nigh inevitable result of having free trade between a country with a very low savings rate and one with a very high one (like China). If we were just trading with ourselves, we'd be going into debt to ourselves, so our overall net worth wouldn't change. But because foreign debt is involved, our national net worth can be reduced this way.
What are the implications?
In the first case above (the environment), the implication is to tax imports from nations with lower environmental standards.
In the second case (consumption vs. saving), the implication is to tax U.S. imports sufficiently to bring our trade into balance.
In technical economic terms, the way to say all this is that the whole world is not an optimal free-trade area. Optimal free-trade areas haven't had a lot of attention lately from economists (most of whom believe in free trade simpliciter as the best option), but optimal currency areas are a reasonably well-developed concept. What economists need to take more seriously is the similarities in the underlying reasoning between the two.
The ideal free-trade area may be quite large. And the ideal tariff between many nations may not be that high. But the ideal free-trade area isn't the entire world, and the ideal tariff isn't always zero.
There are plenty of other reasons to maintain national economic borders. One of them, which is increasing in importance in our increasingly high-tech world, is that there is an unavoidable publicly-financed component to innovation. Despite the Silicon Valley myth of rugged individualism (which I hear all the time here in San Francisco), the reality is that government inputs to major high-tech industries from semiconductors to aircraft have been huge. And it's hard to justify spending money on supporting, say, basic scientific research if that research is just going to be commercialized abroad. Worse, without capturing its value here, we won't have the tax base to pay for the next round of research.
Globally, for good or ill, the nation-state is still where the buck of political legitimacy stops. Higher and lower political entities, from Kansas to the United Nations, enjoy legitimacy only because nation-states have given it to them. So even if other instruments for controlling the world economy can be developed over time, the nation-state will be the bottleneck for developing them. A blanket rejection of even the mildest economic nationalism simply hands a blank check to multinational corporations, foreign powers, and (distorted) market forces to do as they please.
So do we need nations? If anyone is seriously asking that question without knowing the answer, and if they are active voters, the US is over. People are seriously in doubt of the need for nations, and so our nation will end. Very soon. If people don't think we need it, it will end.
Flee now or arm yourselves.
But protectionism would be a disaster, producing inefficiency, lowering productivity, increasing inflation, and allowing the politically powerful, both bureaucrats and organized corporate and union lobbies, to protect their turf at the expense of average Americans, as the auto lobby did in the 1970’s. The U.S. has agricultural protection and subsidies now – and they go to powerful, connected farm lobbies. Tariffs on foreign sugar have driven some American candy makers out of the U.S. Trade produces efficiency, eliminates uncompetitive industries, and keeps self-interested protectionist lobbies at bay.
Also, most direct foreign investment goes to high wage, capitalist countries, like the U.S, the U.K, and the EU not to emerging countries with weak labor standards. The race to the bottom scenario is tremendously exaggerated. And we are going to start taxing poor emerging economies because their environmental standards? By that logic Canada should tax imports from the U.S. as they have higher standards.
"Let's start with an example that's easy to understand, one quite familiar from complaints by the unions and the environmental movement: What if environmental or worker-safety standards are higher in one nation than in another? Then having free trade is obviously an open temptation to just move production from the former to the latter. It may not literally be a race to the bottom, i.e. fast and reaching the absolute worst standard, but it sure produces pressure in that direction."
Here's a hint: While it produces pressure in that direction, modern society als produces pressure not to do so. When the country you're moving out of is a major market of yours, pi***ing off a load of your most important customers might not be such a good idea. Usually, the move looks good on paper, but when you add the added costs of marketing into the equation, it doesn't look so good anymore.
When Eastern Europe joined the EU, a lot of companies raced to move their production there. A whole lot of them came back recently, because superior infrastructure, a higher supply of well-trained workforce and not the least the appreciation of the customers made it the economically sound thing to do.
The ideas the author grounds his theories on are part of the outdated short-term-benefit oriented ideology that brought us the whole mess to begin with.
What the author misses is that other countries have profited considerably from the lowered trade barriers and their helping countries like Greece, Portugal and Ireland now is nothing less than giving back some of that profit. What the author also misses that exchange rates are not the only risk factor. Economic stability in itself is one. With the Euro, inhabitants of Greece, Portugal and all the other countries having economic problems right now retain a minimum of buying power, and with that can retain a minimum of demand of foreign products, that wouldn't exist if they were fully decoupled. Their local currency would go down the drain, prices for foreign products would soar astronimically, and German, French or British companies would see their sales in these countries go down the drain along with the currency. In theory, they could set most of their local marketing and sales force free, because there would be little they can do.
The author neglects that stability of any kind is an economic advantage that's worth hard cash for companies.
In terms of the current topic, the Greeks are going to be Greeks no matter what. But how much does that matter economically?
Using the same currency doesn't remove the risks of defaulting, etc. by any given nation or equalize the risk between nations using the same currency, e.g. Germany and Greece. From the perspective of the borrower, the default risk is central.
So how does Greece get to raise funds almost as easily as Germany--your sentiment--when its default risk is much higher?
A big part of the tax cutter's argument is 'this state has an inferior business climate'. California's ability to regulate labor practices is compromised by the wedged open borders it shares with the other 49 states.
California is a state where some people are beginning to see the need for doing things the right way, especially environmentally. That means addressing the true costs and taking economic responsibility for the consequences of your production methods (emissions and other pollutants)
However, if in another state lawmakers allows businesses to continue to defer cleanup costs (or consequences of non-cleanup) to the public, California businesses will suffer a competitive disadvantage.
So responsibility is punished, rather than lauded. Do the right thing.. too bad it's more expensive. The free trade with other states undermines efforts in California to regulate environmental costs. It lets business flee to the least restrictive state, dropping the whole country to the lowest common denominator.
I think free trade within countries should have some limits. Tariffs could be applied based on differences in wage laws, safety standards and environmental standards. This would ameliorate the disadvantage that comes with doing things properly.
Oh, my God. I can't believe you just said that. Would you be implying that this applies outside the bilateral example you gave, to other histories and systems and culture? This is such 19th Century European Imperialist superiority-complex baloney ... just kidding. Thanks for saying this. Culture matters to prosperity.
The rest of your article is an exhaustive (by popular media standards) examination of the issues, many of which you got wrong. A sovereign currency is only valuable if you can get foreigners to borrow money denominated in your currency. Otherwise, it's all a wash.
As for protectionism, the problem is people. All things are possible in theory, it's when people get involved that the variables spin out of bounds. If we were Germany, which we're not, we could apply that very disciplined, focused, rational touch to our import duty structure to achieve the objective without overshooting. We are America, the one dependable feature of our system is unintended consequences (google smoot-hawley).
We need solutions that suit our national character, rather than trying to force fit unsuitable solutions atop our inflexible culture. That solution is out there, if we would only look for it.
"Nations and countries are as interdependent as are the members of a family. The policies of nations and governments must involve the essence of equilibrium and of fairness, which will produce peace, harmony and happiness.
No nation, no country is superior or inferior to another. It is the duty of the government to protect and promote the welfare of the nation, and it is the duty of every individual to be who he is."
- World Teacher Maitreya through an associate as reported by Share International
Ian is right though. Countries exist for a reason. Some are richer than others and have more or less rule of law. Free trade wants to level currencies and wealth, as the trade relations of China and the U.S. illustrate. To rationalize every national economy in the world to the same currency and wage means grievous losses to the richer nations that might even cripple their ability to drive economic development. Short term exploitations of free trade wage differentials opportunities is not the answer.
In any case the morality of capitalism needs to be challenged which is that you will be rewarded based on your factor endowments. What about resource poor areas? What about differing cultural practices?
Back to Marxian morality then: "From each according to his means, to each according to his needs" (or her). The EURO made the Greeks and others too greedy for their own good it is true. However, it is interesting that Germans like making use of unity of currency when it suits them but don't want to take responsibility for their fellow members within the EU.
What role do US Corporations play and how are they regulated in these scenarios? (Seems to me that they have free reign to transfer intellectual property, and all manner of business 'best practices' to foreign countries, eg, China........and to play their own independent tax and currency games). Some of these corp economies are larger than countries.
What part does US labor play in all of this? How do you keep US labor from being decimated by global 'commoditization' of labor? It's more than manufacturing labor, it's all classes of labor that do not require a physical presence in the US, etc.
Seems like Pandora is out of the box, and Washington hasn't noticed..........or they have noticed and are frantically creating 'great recessions' and making other intelligent moves to bring back America.
As well as the fact that more educated and skilled labor commands higher wages and better benefits and therefore become targets for outsourcing.
that is why white collar jobs like CAD designers, engineers, accountants, medical techs, legal services, are some of the fastest rates of outsourcing