Tuesday, February 3, 2009

Co-ordinate policy or go protectionist?

Paul Krugman (and here) makes an interesting (and bound to be controversial!) point - under extraordinary circumstances, caught in a global economic slump and a liquidity trap, and when governments across the world have trouble coming up with an effective response, if fiscal policy is not co-ordinated across economies of the world, then there is a strong possibility and economic case for protectionist policies!

The arguement stems from the contention that fiscal policies exhibit positive policy externalities - "My fiscal stimulus helps your economy, by increasing your exports — but you don’t share in my addition to government debt... this means that the bang per buck on stimulus for any one country is less than it is for the world as a whole." Therefore "if macro policy isn’t coordinated internationally — and it isn’t — we’ll tend to end up with too little fiscal stimulus, everywhere".

On the other hand, in the absence of global economic co-ordination, the cumulative effect of all the separate individual protectionist policies that "contained" the effects of fiscal expansion within the respective domestic economies would be to lift the world economy closer to full employment than otherwise, albeit with the attendant trade distortions and the shattering of the hard-won achievements of 70 years of trade negotiations.

This comes in the context of a "Buy American" provision in the Obama stimulus bill approved by the House of Representatives that requires preference be given to domestic steel producers in building contracts and other spending. William Buiter takes on the protectionists here in a scathing indictment.

Update 1
Dani Rodrik, in an ever so slight echo of protectionism, makes the case for a "policy space" in the constitution of the WTO, so as to "ensure that developing countries can employ the kind of trade and industrial policies needed to restructure and diversify their economies and set the stage for economic growth". These include many policies - subsidies, domestic-content rules, reverse engineering of patented products - used by nations historically in their path towards development and globalization, and which are currently not allowed under WTO rules.

Duncan Green of Oxfam too makes much the similar point, affirming that "trade tariffs, and industrial policy in general, have played a vital role in the history of almost every successful economy, but the benefits of state intervention decline as an economy develops". In other words, history leads to the argument that protectionism makes more sense in developing countries than in rich ones.

Update 2
Greg Mankiw makes an interesting point referring to the new US Treasury Secretary, Tim Geithner's comment before taking office that the Chinese were "manipulating" their currency, thereby conferring unfair advantage to its producers over others. He highlights another dimension to the cheaper yuan - US consumers get cheaper products (thereby keeping their borrowings down), and the dollars accumulated by the China in forex reserves then gets invested in US Treasuries at low yields, thereby providing cheap financing for US deficits.

No comments: