The ebb and flow of protectionism has always lurked in the continuum of world economic history. It is not hard to understand why. Like military security, nation-states take matters of economic security very seriously. When either appear threatened - for whatever the reason - countries feel compelled to defend themselves. But the analogy quickly breaks down.
While military success might be necessary to guarantee political freedom, cross-border economic battles are complicated by the co-dependencies of international trade and capital flows. One party's defensive action can easily be viewed as an offensive threat by another - triggering a sequence of responses and counter-responses that can lead to trade wars and protectionism. Such is the case today, with the mounting tensions of globalization pushing the world uncomfortably close to the slippery slope of protectionism. What can be done to arrest this dangerous trend?
In my opinion, this question can best be addressed through the lens of an increasingly precarious US-China trade relationship - quite possibly the most important bilateral economic relationship in the world. In essence, it boils down to today's global hegemon versus what could well be the hegemon of the future.
Subscribe to MoneyWeek
Subscribe to MoneyWeek today and get your first six magazine issues absolutely FREE
Sign up to Money Morning
Don't miss the latest investment and personal finances news, market analysis, plus money-saving tips with our free twice-daily newsletter
Don't miss the latest investment and personal finances news, market analysis, plus money-saving tips with our free twice-daily newsletter
Unfortunately, this relationship is in serious trouble. China accounts for the largest portion of America's record foreign trade deficit - 25% of the shortfall in 2005 - and there are currently in excess of 20 anti-China bills pending in the US Congress. If these two nations can get their economic relation right and diffuse the cross-border tensions now building between them, it will be an important example for the rest of the world. If they can't, globalization may well be in serious trouble.
It's not hard to pinpoint the source of the economic tension between the US and China. In its most basic sense, it's all about prosperity - China wants it and America wants more of it. China's approach as the new entrant to the arena of global commerce has been through the production side of the equation - a classic avenue of economic development. The US and its ever-voracious consumer remain the leading drivers on the demand side of the equation. This simple contrast between supply- and demand-directed growth unlocks many of the important implications that have been key in driving a wedge between these two powerful economies.
That's especially the case with respect to saving disparities. Lacking in support from self-sustaining internal demand - especially private consumption - China has the highest saving rate of any major economy in the world. Lacking in support from domestic income generation, America's consumption binge has been accompanied by the lowest saving rate in the world. In 2005, China's gross national saving rate was close to 50% - about four times the 13% rate in the US.
And, of course, the comparisons are even more worrisome when calculated in net terms - after stripping out the depreciation of worn-out capacity. On that basis, the US net national saving rate effectively fell to "zero" in the second half of 2005. Without any net saving, America has no choice other than to import surplus saving from abroad - and run massive current account and trade deficits to attract that capital.
Conversely, without consumption, China exports its surplus saving - and runs massive current account surpluses with the rest of the world. The tension arises because of the almost magnetic attraction of these two economies - the US has become China's biggest export market and China has become the largest bilateral piece of America's multilateral trade gap.
What then is the mechanism by which macro tensions between China and the US are transmitted into the political arena? In my view, that's where the global labor arbitrage comes into play. By our calculations, in 2004, average hourly compensation in Chinese manufacturing stood at only 3% of comparable pay rates in the US. And that's after allowing for double-digit manufacturing wage inflation in China of about 12% per annum since 1999.
It's not just that a saving-short America is sourcing an increasing portion of demand from a low-wage Chinese economy. It's that US real wages have been nearly stagnant for nearly a decade - rising at slightly less than a 1% average annual rate since 1995. Near-stagnation in real wages is an especially bitter pill to swallow in that it has occurred in the context of around 3% productivity growth over the same period. Consequently, the global labor arbitrage appears to be operating mainly through the price channel (real wages) rather than through quantities (hiring) - an outcome that tempers concerns over job security but heightens the angst over income insecurity. And that's where Washington's increasingly populist politicians enter the fray - pinning the blame on China as the culprit behind the squeeze on middle-class real incomes.
I've simplified the story a lot to get to the punch line - that the "win-win" theories of globalization are in real trouble. The basic conclusion of Ricardian comparative advantage that all economists are taught to worship from birth holds that trade liberalization not only brings poor workers from the developing world into the global economic equation (win #1), but workers in the developed world then benefit by buying low-cost, high-quality goods from the developing world (win #2).
The theory breaks down because of a new disruptive technology - in this case, the Internet - that dramatically accelerates both the speed and scope of worker displacement in the developed world. It used to be that such workers would eventually - with considerable dislocational distress, to be sure - seek and secure refuge in the non-tradable segment of their economies.
The shocker is that the sense of security in services has effectively broken down. In recent years, IT-enabled connectivity has quickly migrated up the knowledge worker occupational hierarchy in once-nontradable services, denying displaced workers in the developed world the comfort (i.e., sustainable labor income generation) of enjoying the benefits of the second win of globalization.
I recently participated in a seminar on "Global Competition and Comparative Advantage" sponsored by the Woodrow Wilson International Center for Scholars in Washington, DC (see their website, www.WilsonCenter.org, for a detailed summary of this 13 June 2006 conference). I had the honor of sharing the podium with two of the giants of modern trade theory - Paul Samuelson of MIT, who basically developed the modern-day version of the theory of comparative advantage, and William Baumol of NYU and Princeton, who led the way in exploring the ramifications of nontradable services.
Both of these gentlemen cautioned strongly against dismissing the plight of today's generation of trade-displaced workers in the developed world. Samuelson stressed that in an earlier era of globalization, from 1880 to 1914, a comparable burst of innovation - in this case, the advent of the factory assembly line - lowered the standard of living for many workers in the US. "I am not here to be an optimist or a pessimist," Samuelson stated matter-of-factly, "but a realist." He concluded that it's pretty clear a theory is in trouble when it fails the simplest of reality tests. "Displaced workers who have lost their jobs forever - be they blue or white-collar - draw no consolation from the theoretical conjecture of the win-win trap of the globalization advocates."
With one of the theoretical pillars of modern economics unable to explain the way the new world is working, the economics profession has not been very helpful in suggesting a way out. This has given rise to a certain sense of anarchy from the academic and political communities. At one end of the spectrum is the "new-new" trade theory suggesting that there is really nothing to worry about - that America (the consumer and dis-saver) has found its perfect symbiotic partner with China (the producer, saver, and financier). At the other end of the spectrum are populist politicians who want to charge China with the high crimes of violating the rules and conventions of free and fair trade. And then there are those like myself who are stuck in the uncomfortable middle ground - with some tough answers that lack the quick fix that politicians always seek or the painless remedy that voters always seem to demand.
In the spirit of a "Samuelson realist," I would offer three basic guidelines to get the US-China relationship - and the globalization debate - back on track. One, admit there is a problem - that courtesy of IT-enabled globalization, worker displacement and wage compression in the developed world is in uncharted territory. The rich industrialized economies need to respond by investing in human capital, educational reform, and basic research.
Two, the developing world needs to be engaged, not disenfranchised. Completion of the Doha round of trade liberalization is essential, as is compliance with new and rigorous standards of intellectual property protection - the residue of comparative advantage in the developed world.
Three, macro policies need to be realigned. The US must adopt a pro-saving policy - facing up to structural budget deficits and the pro-consumption biases of the tax code and a bubble-prone central bank; such an approach would tilt national saving to the upside - reducing the risk of increasingly contentious current-account and trade deficits. China, for its part, must deliver on the pro-consumption intent of its newly enacted 11th Five-Year Plan; that approach would reduce its excess saving and temper the destabilizing impacts of its trade and current account surpluses.
There's nothing simple or painless about these suggestions. The cynic would say that's the problem. The realist would say that's the challenge. In that latter vein, I continue to be impressed by the newfound religion of the stewards of globalization. Since the late-April G-7 and IMF meetings, the IMF has moved ahead of schedule in putting its new multilateral surveillance and consultation framework into place. I also take heart in the recent actions of the world's major central banks. In my view, they are finally taking dead aim on the excesses of the global liquidity cycle, which have become a breeding ground for global imbalances and trade frictions.
But the protectionists certainly haven't run for cover. China bashing remains a real threat in Washington - underscored by misplaced perceptions of "fair value" for the bilateral exchange rate between the renminbi and the dollar. And I'm afraid on that ground, I take great issue with the broad consensus of my colleagues in the economics profession who continue to maintain that RMB revaluation is the silver bullet in this debate - that an economy with an "undervalued" currency is deserving of trade sanctions.
Currency valuation is an art - not a science. But in a global framework, fixation on bilateral cross rates makes little or no sense. The appropriate metric is the multilateral currency - and on this basis, it is important to stress that China's broad real effective exchange rate has appreciated some 9% since December 2004 - well in excess of its 3% bilateral move against the dollar.
China certainly needs to be held accountable for its role in creating tensions over globalization - especially in the area of intellectual property piracy and in condoning an overheated investment sector that has spawned environmental risks and bottlenecks in many strategic materials markets. But, in my view, currency manipulation is a real "red herring" in this debate.
US-China trade tensions are a microcosm of what's wrong with globalization. Neither side is facing up to the global ramifications of its economic aspirations. America's excess consumption is placing an enormous burden on the rest of the world. China's excess production is doing precisely the same. Painfully, history tells us that bilateral fixes cannot be imposed on a multilateral world. Economies that defend themselves on a bilateral basis ignore the darkest lessons of history at great peril.
Note: The above is taken from Mr. Roach's remarks before the "Symposium on Building the Financial System of the 21st Century: An Agenda for China and the United States" sponsored by the China Development Research Foundation and Harvard Law School and held in Tianjin, China on June 23-25, 2006.
By Stephen Roach, global economist at Morgan Stanley, as first published on Morgan Stanley's Global Economic Forum
