The New Mercantilist Challenge

Dani Rodrik

Jan. 9, 2013 .

This illustration is by Paul Lachine and comes from <a href="http://www.newsart.com">NewsArt.com</a>, and is the property of the NewsArt organization and of its artist. Reproducing this image is a violation of copyright law.
               Illustration by Paul Lachine
 
 
 
CAMBRIDGEThe history of economics is largely a struggle between two opposing schools of thought, “liberalism” and “mercantilism.” Economic liberalism, with its emphasis on private entrepreneurship and free markets, is today’s dominant doctrine. But its intellectual victory has blinded us to the great appeal – and frequent success – of mercantilist practices. In fact, mercantilism remains alive and well, and its continuing conflict with liberalism is likely to be a major force shaping the future of the global economy.
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Today, mercantilism is typically dismissed as an archaic and blatantly erroneous set of ideas about economic policy. And, in their heyday, mercantilists certainly did defend some very odd notions, chief among which was the view that national policy ought to be guided by the accumulation of precious metalsgold and silver.
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Adam Smith’s 1776 treatise The Wealth of Nations masterfully demolished many of these ideas. Smith showed, in particular, that money should not be confused for wealth. As he put it, “the wealth of a country consists, not in its gold and silver only, but in its lands, houses, and consumable goods of all different kinds.”
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But it is more accurate to think of mercantilism as a different way to organize the relationship between the state and the economy – a vision that holds no less relevance today than it did in the eighteenth century. Mercantilist theorists such as Thomas Mun were in fact strong proponents of capitalism; they just propounded a different model than liberalism.
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The liberal model views the state as necessarily predatory and the private sector as inherently rent-seeking. So it advocates a strict separation between the state and private business. Mercantilism, by contrast, offers a corporatist vision in which the state and private business are allies and cooperate in pursuit of common objectives, such as domestic economic growth or national power.
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The mercantilist model can be derided as state capitalism or cronyism. But when it works, as it has so often in Asia, the model’s government-business collaboration” or “pro-business statequickly garners heavy praise. Lagging economies have not failed to notice that mercantilism can be their friend. Even in Britain, classical liberalism arrived only in the mid-nineteenth century – that is, after the country had become the world’s dominant industrial power.
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A second difference between the two models lies in whether consumer or producer interests are privileged. For liberals, consumers are king. The ultimate objective of economic policy is to increase households’ consumption potential, which requires giving them unhindered access to the cheapest-possible goods and services.
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Mercantilists, by contrast, emphasize the productive side of the economy. For them, a sound economy requires a sound production structure. And consumption needs to be underpinned by high employment at adequate wages.
 
 
 
 
These different models have predictable implications for international economic policies. The logic of the liberal approach is that the economic benefits of trade arise from imports: the cheaper the imports, the better, even if the result is a trade deficit. Mercantilists, however, view trade as a means of supporting domestic production and employment, and prefer to spur exports rather than imports.
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Today’s China is the leading bearer of the mercantilist torch, though Chinese leaders would never admit ittoo much opprobrium still attaches to the term. Much of China’s economic miracle is the product of an activist government that has supported, stimulated, and openly subsidized industrial producers – both domestic and foreign.
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Although China phased out many of its explicit export subsidies as a condition of membership in the World Trade Organization (which it joined in 2001), mercantilism’s support system remains largely in place. In particular, the government has managed the exchange rate to maintain manufacturers’ profitability, resulting in a sizable trade surplus (which has come down recently, but largely as a result of an economic slowdown). Moreover, export-oriented firms continue to benefit from a range of tax incentives.
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From the liberal perspective, these export subsidies impoverish Chinese consumers while benefiting consumers in the rest of the world. A recent study by the economists Fabrice Defever and Alejandro Riaño of the University of Nottingham puts the “losses” to China at around 3% of Chinese income, and gains to the rest of the world at around 1% of global income. From the mercantilist perspective, however, these are simply the costs of building a modern economy and setting the stage for long-term prosperity.
 
 
 
 
As the example of export subsidies shows, the two models can co-exist happily in the world economy. Liberals should be happy to have their consumption subsidized by mercantilists.
 
 
 

Indeed, that, in a nutshell, is the story of the last six decades: a succession of Asian countries managed to grow by leaps and bounds by applying different variants of mercantilism. Governments in rich countries for the most part looked the other way while Japan, South Korea, Taiwan, and China protected their home markets, appropriated intellectual property,” subsidized their producers, and managed their currencies.
 
 
 
 
We have now reached the end of this happy coexistence. The liberal model has become severely tarnished, owing to the rise in inequality and the plight of the middle class in the West, together with the financial crisis that deregulation spawned. Medium-term growth prospects for the American and European economies range from moderate to bleak. Unemployment will remain a major headache and preoccupation for policymakers. So mercantilist pressures will likely intensify in the advanced countries.
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As a result, the new economic environment will produce more tension than accommodation between countries pursuing liberal and mercantilist paths. It may also reignite long-dormant debates about the type of capitalism that produces the greatest prosperity.






Dani Rodrik is Professor of International Political Economy at Harvard University’s Kennedy School of Government and a leading scholar of globalization and economic development. His most recent book is The Globalization Paradox: Democracy and the Future of the World Economy.
 


Is China Enough?

Jose L. Machinea

Jan. 10, 2013
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This illustration is by Paul Lachine and comes from <a href="http://www.newsart.com">NewsArt.com</a>, and is the property of the NewsArt organization and of its artist. Reproducing this image is a violation of copyright law.
Illustration by Paul Lachine
 
 
 

BUENOS AIRESFor many countries in Latin America, demand from China has been essential to maintaining high GDP growth rates over the last decade. But will Chinese demand for commodities be enough to sustain high prices for the region’s exports in the coming years?
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During the last two decades, four factors combined to generate a sharp increase in world demand for commodities: rapid growth in global GDP, increasing urbanization in developing countries, a rise in population at a rate of 800 million people per decade, and a significant decrease in poverty. With the exception of global population growth, China has been the most dynamic country in all of these respects.
 
 
For example, the number of Chinese living in poverty fell by 650 million over the last two decades. Moreover, China accounts for half of the global increase of 1.5 billion people earning between $2-13 a day in the past 20 years.
 
 
But should we expect what happened from 1990 to 2010 to continue in the coming decades? To answer that question, several variables must be taken into account: demand growth, technological change, investment, and the commitment to confront global warming, among others. Bearing in mind such complexity, let’s consider only some determinants of demand that are linked to increased income.
 
 
Two factors appear to be the most important: China’s growth rate in the coming years, and whether its growth will be sufficient to maintain high levels of global demand for commodities. Even if it is, the impact is likely to be different for agricultural exporters (the members of Mercosur and some Central American countries) than for exporters of minerals and oil (Mexico and other South American countries).
 
 
Moreover, although fiscal and monetary stimulus in China can compensate in the short term for weaker export demand, this will not be enough to sustain demand growth without economic normalization” in the developed countries. As we know, this is far from assured in Europe; nor is it evident in the United States and Japan – that is, countries that account for roughly 45% of Chinese exports.
 
 
In the medium and longer term, the expected and hoped-for increase in China’s domestic consumption should be the most dynamic element of demand, with export growth continuing to slacken and investment remainingexcept for brief periodsbelow 50% of GDP. This is not guaranteed, however, as progress in establishing social insurancecrucial to increasing consumption – has been relatively slow, while monetary transfers to families (such as those that have been implemented in Brazil, Mexico, and elsewhere in Latin America) might not be feasible, given the logic of China’s political system.
 
  
Even if China sustains rapid growth, it is unlikely to repeat in the next 20 years the extraordinary decrease in poverty witnessed in recent decades. The reason is simple: of the 400 million people living on two dollars a day in 2008, it is possible that “only300 million remain. Moreover, the rate of China’s population growth is close to zero, and will turn negative before 2025. As a result, fewer people will cross the poverty line, although more will see their daily earnings grow from two dollars to five, and from five dollars to ten.
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 That trend will have a differentiated effect on demand for cereals and soy relative to other products that are more closely linked to higher incomes, such as foods containing higher-quality protein, metals, and oil. In terms of the latter products, China might continue to be decisive for global demand growth.
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This is why, in order to maintain food prices in the medium term, other countries or regions will need to start reducing poverty at rates similar to that of China in the recent past. Bearing in mind the differences in their productive structures, sub-Saharan Africa and India appear to be the best candidates, given that they accounted for 1.4 billion of the world’s poor in 2008 and 60% of global population growth.
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Will India and sub-Saharan Africa – which grew at annual rates of 7.3% and 5%, respectively, during the last decade assume the role that China has played in recent years? It seems unlikely, but without them it is difficult to foresee high prices for commodities – and food, in particularover the next two decades. In that case, there will be less time left for the countries that have not taken advantage of the current bonanza to lay the foundations of sustainable growth.

 
 
 
Jose Luis Machinea, former Executive Director of the Economic Commission for Latin America and the Caribbean (ECLAC) and former Minister of Economy of Argentina, is Dean of the School of Government, Torcuato Di Tella University, Buenos Aires.



Chart Of The Day: How The Swiss National Bank Went "All In", Three Times And Counting

Submitted by Tyler Durden

on 01/09/2013 08:15 -0500

 

Think the Fed (with its balance sheet amounting to over 20% of US GDP), or the ECB (at 30% of GDP) is bad? Then take a look at the balance sheet of the Swiss National Bank, whose assets now amount to some 75% of Swiss GDP and which has now "literally bet the bank" in the words of the WSJ not once, not twice, but three times in a bid to keep the Swiss Franc - that default flight to safety haven - low, and engaging in what is semi-stealth currency warfare by buying other sovereigns' currencies for over two years now, although he hardly expect the US Treasury to even consider it for inclusion on its list of currency manipulators - after all, "everyone is doing it".






More from the WSJ:
The nation's central bank is printing and selling as many Swiss francs as needed to keep its currency from climbing against the euro, wagering an amount approaching Switzerland's total national output, and, in the process, turning from button-down conservative to the globe's biggest risk-taker.
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Switzerland's virtue is the root of its problem: broad confidence in the Swiss currency and economy has investors hungry for francs to escape euros, the currency of its shaky European neighbors. Such demand makes francs more expensive and, in turn, drives up the price of Swiss exports.
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In the past three years, the Swiss National Bank SNBN.EB -0.20% has printed francs to buy euros and other currencies in a swelling portfolio of foreign assets four times what it was at the beginning of 2010.
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Nearly every major central bank is buying nontraditional assets to resurrect domestic economies in the wake of the worst global recession in 75 years. The U.S. Federal Reserve is buying mortgages; the European Central Bank is making unusually long loans to banks; and the Bank of Japan is buying real-estate investment funds.
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All risk losing money, but Switzerland's exposure stands out in character and scale: Its central bank is buying assets from other countries and its holdings of currencies, bonds, stocks and gold—nearly 500 billion Swiss francs, about $541 billion—are nearly the size of the nation's gross domestic product. In contrast, the Fed's buying of bonds and mortgages amounts to about 20% of U.S. national output, and the European Central Bank's holdings stand at 30% of total GDP.
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In September 2011, the SNB set a goal of keeping its currency from rising beyond 1.20 francs to the euro, a threshold that SNB Chairman Thomas Jordan has said the bank would fight to maintain "with the utmost determination."

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Given its golden reputation, the franc became a magnet for investors fleeing the beleaguered euro, pushing the currency to levels that threatened to cripple Switzerland's export-driven economy.
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Although Switzerland is best known for chocolates, watches, banking and Alpine resorts, midsize specialized companies form the backbone of a manufacturing industry that accounts for one-fifth of Swiss GDP. Exports produce half the GDP, with the euro zone by far its largest customer.
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Why No Glass-Steagall II?

Barry Eichengreen

Jan. 10, 2013
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This illustration is by Tim Brinton and comes from <a href="http://www.newsart.com">NewsArt.com</a>, and is the property of the NewsArt organization and of its artist. Reproducing this image is a violation of copyright law.
            Illustration by Tim Brinton
 
 
 
MANILA Eighty years ago this month, Ferdinand Pecora, the cigar-chomping former assistant district attorney for New York City, was appointed chief counsel for the US Senate Committee on Banking and Currency. In subsequent months, the hearings of the Pecora Commission featured many sensational revelations about the practices that led to the 1930’s financial crisis.
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More than that, the Commission’s investigation led to far-reaching reformmost famously, the Glass-Steagall Act, which separated commercial and investment banking.
But Glass-Steagall didn’t stop there. It created federal insurance for bank deposits. With unit banking (in which all operations are carried out in self-standing offices) viewed as unstable, banks were now permitted to branch more widely. Glass-Steagall also strengthened regulators’ ability to clamp down on lending for real-estate and stock-market speculation.
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The hearings also led to passage of the Securities Act of 1933 and the Securities Exchange Act of 1934. Securities issuers and traders were required to release more information, and were subjected to higher transparency standards. The notion that capital markets could self-regulate was decisively rejected.
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The contrast with today is striking. Say what you will about the Dodd-Frank Act of 2010, but it is weak soup by the standards of the 1930’s. In response to what is widely regarded as the most serious financial crisis in 80 years, it does much less to change the structure and regulation of the US financial system.
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The explanation is not that the bankers were less well organized in the 1930’s. The American Bankers Association, worried about the fees that banks would be obliged to pay, vehemently opposed deposit insurance. The State Bankers Association, to which many unit banks belonged, condemned the provisions designed to facilitate state-wide branching.
 
 
 
 
Nor is it obvious that the bankers suffered from more adverse publicity. The Pecora Commission hearings were sensational, but it is difficult to argue that the public anger they whipped up was much greater than that which greeted Wall Street’s titans when they testified before the Financial Crisis Inquiry Commission in 2010.
 
 
 
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In fact, Pecora examined only one commercial bank, National City Bank, prior to the enactment of Glass-Steagall. The bank’s chairman, Charles Mitchell, danced around the question of conflicts of interest between his bank’s deposit-taking and securities-underwriting activities. In any case, more attention was paid to the revelation that Mitchell had sold 18,000 bank shares to his wife at a loss to evade taxes. To the extent that the hearings focused on a few bad apples, they made the case for systematic reform less compelling.
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Pecora turned next to the investment banks. This time, the revelation was that J.P. Morgan & Co. had provided special access to initial public offerings for prominent public figures, including a former treasury secretary and future Supreme Court justice. But, again, these disclosures did not speak to issues like the desirability of branching or deposit insurance.


However damning, the revelations were no more embarrassing than the knowledge that Countrywide Financial provided mortgages on favorable terms to “friends of Angelo” (powerful figures close to Countrywide’s then-chairman and CEO, Angelo Mozilo) like former Fannie Mae CEO Franklin Raines and former Senate Banking Committee member Christopher Dodd.
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Another popular argument for the success of 1930’s reform is that Congress had already agreed on a diagnosis of the problem and could build on its own earlier efforts to treat it. Senator Carter Glass had been pushing for years for more permissive branching laws and centralized supervision of banks. He had already introduced a bill containing several such measures in January 1932.
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Similarly, more than 100 bills for federal deposit insurance had been proposed in the preceding 50 years. One, co-sponsored by Representative Henry Steagall, had been passed by the House. The idea, in other words, was already in the air.
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But this ignores the fact that Steagall was not enamored of more extensive branching, which disadvantaged small banks. Glass, for his part, opposed deposit insurance. The final bill passed only when its sponsors agreed to combine deposit insurance with new banking regulation, creating a package with something for everyone.
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In some cases, the reformers were pushing on an open door. National City Bank and Chase National Bank had already announced that they were liquidating their securities affiliates. Underwriting had collapsed, and banks were more than ready to get out of the securities business. The Glass-Steagall separation of commercial and investment banking simply validated a transition that was already underway.
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In 2009-2010, by contrast, the big banks were still seeking to maintain their existing range of activities. This caused the industry to resist strongly efforts to rein in practices like proprietary trading.
 
 

Ultimately, the explanation for the passage of far-reaching financial reform can only be the severity of the crisis. In the 1930’s, the Great Depression brought the entire economy to its knees. The need for root-and-branch reform was undeniable.


After 2008, by contrast, policymakers succeeded in preventing the worst, which ruled out the sense of urgency that surrounded the Pecora Commission hearings. The ultimate irony is that this very success led to less reform.



Barry Eichengreen is Professor of Economics and Political Science at the University of California, Berkeley, and a former senior policy adviser at the International Monetary Fund. His most recent book is Exorbitant Privilege: The Rise and Fall of the Dollar and the Future of the International Monetary System.