Free trade becomes a scapegoat as times get tough

For the past decade and more, the world has experienced all the benefits that a globalised economy brings, at small and containable cost. China's phenomenal growth has been only one part of the success story; cheap goods from emerging economies kept the lid on Western inflation and interest rates, while strong global growth opened up new markets for investors and exporters.

Stable or falling real prices of oil, food and commodities, coupled with the productivity gains attributable to new technology, helped to keep the profit margins of many Western corporations at record highs, while unemployment finally started to fall, even in Europe's most over-regulated economies. The anti-globalisation movement, vociferous a decade ago, was relegated to the fringes of public debate. Gordon Brown was not alone in asserting that the world of “boom or bust” was gone for ever, although he may have been alone in believing that the credit for this was all his.

The test of leadership comes now. Keeping globalisation healthy in hard times will be an exacting task. Hard times are upon us. The upward pressure on oil, food and commodity prices - which, incidentally, is driving up costs in China even more steeply than in the West - translates into lower growth and higher inflation. Businesses are cutting investment; consumer spending is faltering; jobs are being cut; and unions are clamouring for “inflation-beating” pay deals that will, if conceded, stoke inflation further.

The difficulty for politicians, particularly in the US and Britain, is that voters have got so used to more or less uninterrupted growth and cheap credit that they feel angry and betrayed. The temptation to search for scapegoats, preferably foreign, is proportionately high. Just when the value of open economies and free trade most urgently needs strong political advocates, they are - predictably but perilously - in short supply.

Goldilocks is having a bad-hair day and, instead of reaching for the hair conditioner, her hairdressers are throwing tantrums. President Sarkozy's ridiculous outburst against Peter Mandelson last week explicitly and falsely asserted that the EU's modest Doha Round offer to reduce farm subsidies and tariffs would cut EU farm production, thus condemning African children to starvation. This is naked, populist, protectionism, built on a manifest untruth: only look at New Zealand, where farm production and exports boomed after the total removal of farm subsidies.

With farm prices high worldwide, there could be no better time than now to lower protectionist barriers, thus encouraging farmers in the developing world. Instead, so far with German backing, France is pushing for “community preference” in agriculture and an even larger Common Agricultural Policy budget, on the pretext of insulating Europe's consumers from high world prices.

Mr Sarkozy's ultimate goal may be to sink the Doha Round altogether. That is hardly a surprise. Affection for open markets has never been France's distinguishing characteristic.

Much more worrying is the resurgence of protectionism in America. In the Democratic primary campaign, both Hillary Clinton and Barack Obama treated free trade as a horseman of the Apocalypse, depicting a world in which American parents and children compete for minimum-wage jobs while corporations heartlessly shift the better jobs overseas.

Mr Obama claims, for instance, that “entire cities...have been devastated” by Nafta, the North American Free Trade Agreement signed in 1993, which he blames for destroying a million American jobs, when in fact total employment has risen by 27 million since 1993, when the trade deficit with Mexico, his favourite scapegoat, accounts for a hardly significant 1.7 per cent of the US economy - and when, overall, job losses attributable to trade rather than to higher productivity amount to only about 2 to 3 per cent of American layoffs.

Should he win, it is possible that Mr Obama will stop talking nonsense like this, for the simple reason that the cheaper dollar has helped to make exports the brightest part of the US economy, accounting for 40 per cent of growth. Optimists point out that he has so far kept quiet on China.

Perhaps he has been told that price inflation is six points lower for blue-collar Americans than for wealthier ones, because poorer people buy more Chinese goods. However, nothing could be less certain than his conversion to free trade, because the Democrats are likely to increase their majority in Congress, and protectionism is raging in Democrat ranks - witness the 2008 Farm Bill, a $290 billion (£146 billion) monument to protectionism.

It has even infected senior Democrats on the party's small free-trade wing. This month Senator Joseph Biden - a potential Secretary of State, should Mr Obama beat John McCain - said this to a meeting in Venice of the Council for Italy and America: “I tell my Senate colleagues that they can't expect American growth to be as high as it was in the Clinton years, because there are 1.2 billion more people out there competing for American jobs.” Did he really think, I asked, that stealing American jobs is what gets those people out of bed in the morning? Or that the global jobs market is a zero-sum game? And if he didn't entertain these two absurd notions, then why use rhetoric that is bound to feed the protectionism that really would kill off American jobs, and European jobs, and all our jobs? His answer: “I'm a free-trader. But I deal in facts.” When men like Mr Biden are saying things like that, it is not clear that even a resounding victory for Mr McCain, a resolute and convinced free-trader, would be enough to save the Doha Round from Congressional defeat.

That is why Europeans must stop resisting the Bush Administration's efforts to set a rigorous timetable, this month at World Trade Organisation negotiations in Geneva, for concluding the Doha Round before autumn. Delay now really does court the risk of failure. The immediate effect on trade might not be dire. America would still be the world's fourth-most-open economy, after Hong Kong, Singapore and, surprisingly, Turkey, and well ahead of the EU. However, the damage of a perceived American retreat from globalisation would be great.

Economic nationalism is perilously contagious. Politicians need to confront popular anxieties about free trade by doing a far better job of explaining how much we gain from the global expansion of wealth and markets that it stimulates - and how much we stand to lose from protectionism. It is precisely because Peter Mandelson increasingly performs this task, that Nicolas Sarkozy would happily throw his head to the poor of Africa. Brains are a typically French delicacy.

The Return of Inflation?

Robert Samuelson

Forget the housing collapse, the "credit crunch" and -- in isolation -- higher oil prices. The real economic menace may be resurgent inflation, which is the broad rise of most prices. To understand why, some history helps. The government's worst domestic blunder since World War II was the unleashing of high inflation: In 1960, annual inflation was 1.4 percent; by 1979, it was 13.3 percent. This terrified Americans, who feared falling living standards. It also destabilized the economy, causing harsher recessions that culminated with 10.8 percent unemployment in 1982.

We don't want to go there again, and Federal Reserve Chairman Ben Bernanke has been insisting that we won't. In a recent speech, he argued that the economy today is much different from what it was in the mid-1970s. He's right. In 1974, inflation (as measured by the consumer price index) was 12 percent. Unemployment in the parallel recession peaked at 9 percent in early 1975. We're not close to that havoc. Unfortunately, Bernanke's comforting analogy is misleading. The question is not whether it's 1975; it's whether it's 1966.

It was then that the inflationary psychology -- which later led to so much grief -- took hold. Vietnam War spending and the Fed's easy-money policies created an economic hothouse. Government officials and most academic economists underestimated the danger. Inflation crept from negligible levels to 3.5 percent in 1966 and 6.2 percent in 1969. There are eerie parallels now. From 1997 to 2003, inflation averaged slightly more than 2 percent. Now it's 4 percent; some economists soon expect 5 percent. Hmm.

To be sure, differences abound. Then, we had a classic wage-price spiral. Strong consumer demand allowed businesses to raise prices, which spurred demands for higher wages that companies paid because they needed the workers and could recover the costs through higher prices. In 1959, labor costs rose 4 percent; firms could offset most of that through efficiencies (a.k.a. "productivity"). By 1968, labor costs were up a less-forgiving 8 percent.

By contrast, today there's not yet a wage-price spiral. Inflationary pressures seem to originate mostly in rising raw materials prices. In 2002, oil was $25 a barrel; now it's $135. Corn was $2.30 a bushel; now it exceeds $7. Copper was 70 cents a pound; now it's $3.80. Meanwhile, a powerful anti-inflationary force -- cheaper manufactured imports -- is waning. The weaker dollar and higher transportation costs have raised import prices. In the past year, prices for imported consumer goods (excluding autos) are up 3.6 percent.

We seem to be hostage to global forces. Economists Richard Berner and Joachim Fels of Morgan Stanley call this the "new inflation," because it's not easily squelched by domestic policies. Up to a point, that's true. Although the Fed influences interest rates, it doesn't own oil rigs or cornfields. Long-term price relief for oil involves switching to more-fuel-efficient vehicles and increasing worldwide, including American, oil production. Removing subsidies for corn-based ethanol would reduce food price pressures.

Still, all large inflations involve "too much money chasing too few goods," as economist Milton Friedman often noted, and this episode is no exception. The Fed's easy-money policies have global effects. Many countries peg their currencies to the dollar -- formally or informally -- and shadow Fed policies. Meanwhile, oil producers and other commodity exporters have been flooded with dollars; in practice, the extra cash allows them to run easy-money policies. The result is that despite the U.S. slowdown, much of the world is booming. Developing countries, now about half the global economy, have been growing at about 7 percent since 2002. Higher inflation is a worldwide phenomenon. In China and India, it's about 8 percent. In Russia, it's 15 percent.

One antidote to rising raw materials prices is for the Fed to reverse its easy-money policies. Combating inflation is rarely popular or easy, because it involves slowing the economy -- even inducing a recession -- to relieve pressures on prices and wages. Unemployment rises. There are usually plausible reasons for waiting. Surely there are now. Housing remains in disarray. More loan defaults could increase bank losses. No matter what the Fed does, there are dangers. Perhaps inflation will spontaneously subside (as some Fed officials hope) because the economy is already weak.

But similar arguments for delay were made in the 1960s, with disastrous results. The resulting inflationary psychology made inflation harder to extinguish. The initial unwillingness to take a modest slowdown or recession led to deeper subsequent recessions. There are now signs that we are at a similar juncture. Surveys show that people's "inflationary expectations," after years of stability, are rising. The Fed is holding its key interest rate at 2 percent, well below prevailing inflation. In the 1970s, this condition stoked inflation. An indecisive Fed risks repeating its previous blunder.

How to see world economy through two crises

By Martin Wolf

Two storms are buffeting the world economy: an inflationary commodity-price storm and a deflationary financial one. Last week I argued that exchange-rate regimes were a link between these distinct events. This week, let us look at how to sail on these storm-tossed seas.

EDITOR’S CHOICE

Economists’ forum - Nov-16

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The place to start is with the world economy as a unit. The more globalised economies become, the more appropriate it is to think of the world economy in this way. So what have we learnt about the world economy as a whole? The answer is that it is running into limits on resources, at least in the short term.

Our civilisation is based on fossil fuel. But since the end of 2001, the real price of oil has risen some six-fold. Today, the real price is higher than since the beginning of the previous century. As the World Bank notes in its Global Development Finance 2008, global oil supply stagnated in 2007. This, argues the report, “contributed to the large decline in stocks in the second half of 2007 and to sharply higher prices”*. These increases may prove temporary, as happened after the spikes of the 1970s, or permanent. We do not yet know.

Jumps in energy prices have at least three effects on the economy.

First, they increase headline inflation. In emerging economies, above all, bad inflationary surprises have become the norm (see chart).

Second, they lower potential supply, by squeezing profits in energy-consuming activities, forcing businesses to scrap energy-intensive capacity, and making it necessary to invest in new and more energy-efficient capacity.

In its latest Economic Outlook, the Organisation for Economic Co-operation and Development discusses the consequences of such a negative supply shock on member countries**. It makes two large points: first, uncertainty about current levels and future growth of potential output has risen; and, second, the adverse effects of this may be sizeable.

The OECD estimates that the recent rise in the relative real price of oil has lowered steady-state output by 4 per cent in the US and 2 per cent in the eurozone and lowered potential growth, in the medium term, by 0.2 percentage points and 0.1 percentage points, respectively. This is not trivial: in the case of the US, the decline in the growth of potential output must be at least 10 per cent of potential growth in output per head. In the more advanced emerging economies – and particularly a fast-growing industrialising economy like China – the reduction in the potential rate of growth may well be greater still.

Third, energy price jumps alter the level and distribution of global demand. The move from a price of close to $53 a barrel at the beginning of 2007 to $136 now, increases the annual cost to consumers by around $2,600bn annually, which is a tax of about 4.5 per cent on global non-oil output. Some two-thirds of this transfer is from oil-importing to oil-exporting countries. It is also from those who spend to those inclined to save, at least in the short term.

This shift itself will curb the rise in global demand. So, too, will the financial crises in the US and other high-income countries and the closely related collapse of several huge house-price bubbles. In the high-income countries, growth is forecast by the OECD to slow to a little below trend this year and next. As one would expect, the biggest decline is in the US, with gross domestic product growth of 1.2 per cent this year, almost all of which is expected to be contributed by the rise in net exports. From being a locomotive of growth, the US has become dependent on growth elsewhere.

Yet will this decline in the rate of growth in the high-income countries cool an overheated world economy sufficiently? Perhaps not. The OECD expects a decline in growth outside the OECD, but to levels still above (a hard to measure) potential (see chart). The World Bank’s Global Development Finance does expect a marked decline in developing country growth, though to still high levels, from 7.8 per cent in 2007 to 6.5 per cent this year and 6.4 per cent in 2009. Chinese growth is forecast to slow from 11.9 per cent in 2007 to 9.4 per cent in 2008 and India’s from 8.7 per cent to 7.0 per cent.

Yet, as I argued last week, global monetary policy is probably too loose, despite the adverse impact of the credit crisis on high-income countries. In many emerging countries output is growing quickly, with inflation rising strongly. If, as seems likely, the world economy cannot grow as fast as people hoped only a year or two ago, emerging economies have to be part of the adjustment. This will become still more obvious when, at last, the high-income countries recover fully.

Against this difficult background, what are the right responses and how should they be distributed, across the globe? These need to be divided into the short term and the longer term.

In the short term, the biggest monetary policy requirement is a tightening in emerging economies, many of which now have strongly negative real interest rates. A precondition for such a tightening is a relaxation of exchange rate targeting. Monetary tightening is less obviously necessary in high-income countries, though the US Federal Reserve may have cut too far.

As important is letting the jumps in energy prices pass through, so forcing the needed adjustments in energy use. The beneficiaries of the subsidies offered by many emerging countries are overwhelmingly in upper-income groups. In India, the cost of fuel subsidies is now almost as large as public spending on education: this is scandalous. No less important, however, is abandonment of the silly idea that price jumps in oil or food are the result of wicked “speculation” – a fantasy promoted by dangerous populists across the globe.

Finally, it is essential for the rich countries to cushion the poorest people and countries against such shocks. The aim should be to reduce the pain and to finance necessary adjustment, but not prevent it.

In the medium to long term, the biggest priority is to release energy constraints on growth. This means increased public and private investment in energy research, particularly in renewables. The challenge is huge, but must be met.

The shocks are large. But the more significant one is the high price of energy. The financial crisis was an avoidable stupidity. Rising prices of energy are a bitter reality. The world must adjust to this unpleasant new threat. Ideally, countries would act together. But whether they act together or not, they must act. Otherwise, greater danger – even a bad dose of stagflation – lies ahead.

Political Speculators

Every dogma has its day, and so it is with the posturing that blames the run-up in oil prices on "speculators." The new political consensus is that further "common-sense regulation" of the energy futures market is necessary. Let's grant that the sentiment is common, but the sense – like the evidence – is nonexistent.

On Sunday, Barack Obama rolled out a proposal that will supposedly thwart market manipulation by "a few energy lobbyists and speculators." John McCain chimed in that Mr. Obama was merely following his lead; last week, the Republican denounced "some people on Wall Street" for "gaming the system." If there's a Congressman who isn't calling for his own crackdown, he's gone into witness protection. And sure enough, even this week's impromptu oil summit in Jeddah blamed "speculators" for high prices.

The futures market may be a convenient scapegoat, but it's simply a price discovery mechanism. Major energy consumers – refiners, airlines – buy and sell these contracts to lock in goods at a future price, as a hedge against volatility. Essentially, they're guesses about coming oil supply and demand, as well as the rate of inflation. The political theory is that such futures trading is creating a bubble in the spot market (i.e., oil purchased for immediate delivery) beyond oil fundamentals. Thus, $4 gas.

But there's no inherent reason to "bet" that commodities will go up rather than down. Bet wrong – place all your chips on red, say – and you lose. If a company purchases the future right to buy oil at $140 a barrel and it instead sells for $130, the option is worthless. Besides, somebody has to take the other side of any futures contract: Some are trying to predict where the price will go in the future, while the other side is attempting to sell its future price risk. But no one knows how things will end up.

Mr. McCain calls such exchanges "reckless wagering." But speculators – normally known as "traders" – are really managing the exposure risks of American businesses to higher oil prices. Traders not affiliated with major producers or consumers provide liquidity to the market. Without the second group, futures markets would be determined exclusively by commercial participants. Another word for this is a cartel.

One omnipresent talking point is that the so-called "Enron loophole" must be closed. A provision inserted in legislation in 2000 exempted certain oil contract exchanges where transactions were made via computer and telephone, rather than on a trading floor, from regulations that govern other exchange-traded commodities. But Congress ended that practice as part of its most recent farm bill, and there's no evidence that "over the counter" trading has caused the increase in oil prices. The political enthusiasm seems to arise solely from the word "Enron."

Mr. Obama and his fellow Democrats are also exercised because the U.S. Commodity Futures Trading Commission (CFTC) doesn't directly oversee U.S. subsidiaries of foreign exchanges. For instance, the global futures market of London-based Intercontinental Exchange is regulated by the U.K. Financial Services Authority. But the FSA has extensive information-sharing agreements with the CFTC. It also has similar standards for the daily position and trade monitoring that ensures market integrity and transparency. In this global business, some of the more stringent antispeculation proposals would merely divert futures trading to Dubai or less regulated exchanges.

Another supposed problem is the rise of commodity index funds, a newer market that is estimated at anywhere from $140 billion to $250 billion. Michael Masters, a Virgin Islands-based fund manager who has the ear of Democrats, blames pension funds and university endowments. He calls them "index speculators." Essentially, these investors buy futures and roll them from month to month as they come due, allowing a constant investment without holding oil or natural gas stocks.

Yet these financial instruments are only new in the sense that they apply traditional stock-market indexing to commodities. It's hard to see how this is irresponsible, and if anything it's the reverse: Indexing is favored by investors who think it's imprudent to gamble on short-term price swings.

* * *

On the other hand, inflation does lead to a misallocation of resources, so it's not surprising that the Federal Reserve's weak dollar policy has driven investors to commodities to protect themselves. Loose monetary policy has caused price jumps across nearly all commodities, including surges in grains and precious and base metals. The Fed's rate-cut bender is the most important reason oil is up so sharply since last August.

The other major factor is supply and demand, as prosaic as that might seem amid today's political agitation. Energy consumption is surging in China and India, and global supply is not growing fast enough to keep up. Congress could do something useful if it opened up America's vast natural resources, which are blocked by environmentalist romanticism. But then, it's so much easier to shoot the price messengers.

The Bush Doctrine Is Relevant Again

Here's a prediction: Zimbabwe's Morgan Tsvangirai will win this year's Nobel Peace Prize.

He would be its worthiest recipient since the prize went to Burma's Aung San Suu Kyi (one of the prize's few worthy recipients, period) in 1991. He deserves it for standing up – politically as well as physically – to Robert Mugabe's goon-squad dictatorship for over a decade; for organizing a democratic opposition and winning an election hugely stacked against him; and for refusing to put his own ambition ahead of his people's well-being when the run-off poll became, as he put it last weekend, a "violent, illegitimate sham."

AP

Morgan Tsvangirai

Here's another prediction: Mr. Tsvangirai's Nobel will have about as much effect on the bloody course of Zimbabwe's politics as Aung San Suu Kyi's has had on Burma's. Effectively, zero.

Zimbabwe is now another spot on the map of the civilized world's troubled conscience. Burma is also there, along with Tibet and Darfur. (Question: When will "Free Zimbabwe" bumper stickers become ubiquitous?) These are uniquely nasty places, and not just because uniquely nasty things are happening. They're nasty because the dissonance between the wider world's professed concern and what it actually does is almost intolerable.

Look at the legislation that has been proposed or passed in the U.S. Congress on Darfur. There is the Darfur Peace and Accountability Act (H.R. 3127), signed by President Bush into law in 2006, which sanctions officials identified as responsible for the genocide. There is House Resolution 992, which urges the president to appoint a special envoy to Sudan. (The president did appoint an envoy; care to remember his name?)

There is the 2007 Sudan Accountability and Divestment Act, which allows (but does not require) U.S. states and municipalities to divest from companies doing business in Sudan. There is Senate Resolution 559, urging the president to enforce a no-fly zone over Darfur. There is the Clinton Amendment, the Reid Amendment, the Menendez Amendment, the Durbin/Leahy Amendment, the Jackson Amendment, the Lieberman Resolution, the Obama/Reid Amendment and the Peace in Darfur Act.

This is a partial list. Meantime, here are the accumulating estimates of the conflict's toll on Darfuri lives. September 2004: 50,000, according to the World Health Organization. May 2005: between 63,000 and 146,000 "excess deaths," according to the Center for Research on the Epidemiology of Disasters at Belgium's Catholic University of Louvain. March 2008: 200,000 deaths, according to U.N. officials. April 2008: The U.N. acknowledges the previous month's estimate might have undercounted about 100,000 victims.

In a video clip for the Save Darfur coalition, Barack Obama offered that the genocide is "a stain on our souls." His proposal for removing it? "Ratcheting up sanctions" on the Sudanese government and making "firm commitments in terms of the logistics, and the transport and the equipping" of an international peacekeeping mission for Darfur. No word, however, as to whether Mr. Obama would actually risk the lives of American soldiers to stop the slaughter.

It's a similar story in Zimbabwe. The U.N. Security Council met yesterday to discuss the crisis, while British Prime Minister Gordon Brown told parliament "the world is of one view: that the status quo cannot continue."

But, of course, the status quo will continue. Just possibly, Mr. Mugabe and his senior ministers will no longer be allowed to travel to Europe, though that does nothing for the people of Zimbabwe. Other sanctions will have no effect: The regime is already busy expelling relief workers and seizing food aid. Mr. Mugabe wants "his people" to die – it means fewer mouths to feed, and fewer potential opposition supporters to jail, maim or murder.

A solution for Zimbabwe's crisis isn't hard to come by: Someone – ideally the British – must remove Mr. Mugabe by force, install Mr. Tsvangirai as president, arm his supporters, prevent any rampages, and leave. "Saving Darfur" is a somewhat different story, but it also involves applying Western military force to whatever degree is necessary to get Khartoum to come to terms with an independent or autonomous Darfur. Burma? Same deal.

International relations theorists, including prominent Obama adviser Susan Rice, justify these sorts of interventions under the rubric of a "Responsibility to Protect" – a concept that comes oddly close to Kipling's White Man's Burden. So close, in fact, that its inherent paternalism has hitherto inhibited many liberals from endorsing the kinds of interventions toward which they are now tip-toeing, thousands of deaths too late.

So let's by all means end the hand-wringing and embrace the responsibility to protect, wherever necessary and feasible. Let's spare the thousands of innocents, punish the wicked, oppose tyrants, and support democrats – both in places where it is now fashionable to do so (Burma) and in places where it is not (Iraq). If that turns out to be Mr. Obama's foreign policy, it will be a worthy one. It does come oddly close to the Bush Doctrine.