Economics blog - Why protectionism did not cause the Great Depression

Generali

Sir_Humphrey wrote: »

Actually, Paul Krugman made a similar argument on his blog the other day.
http://krugman.blogs.nytimes.com/2009/02/01/protectionism-and-stimulus-wonkish/
http://krugman.blogs.nytimes.com/2009/02/02/more-on-protectionism-wonkish/
I will take Generali's comments about the electoral franchise as a joke as I am sure it is intended.
If any can suggest how the world trade can be rebalanced without some form of limited protectionism, I would be interested to hear their ideas.

It is, of course, a joke.

This isn't:

The normal way to rebalance world trade is through the mechanism of floating exchange rates. If you're importing more than you export, your exchange rates will fall until you're back in balance, pretty much. If you export more than you import then the opposite mechanism will apply.

Over the past few years a lot of money has been put the way of speculators and so trade flows have been dwarfed by speculative investments, especially those by Mrs Watanabe investing Japanese household savings into the Carry Trade. The Carry Trade was financed by people borrowing money at very low interest rates in Japan and lending it at higher rates elsewhere.

There is a body of opinion that this is the biggest group buying RMBSs/CDOs etc. I have my doubts but it is perfectly possible.

Now this distorting flow of money has been cut, why not just let trade flows normalise through the usual mechanism of the FX markets? I don't see what could be simpler and less costly than just letting markets find their own level.

If you think Ricardo was wrong then I'd be very interested to understand why in detail. IMO he was possibly the greatest mind of the C19th except Darwin.

pjala

Having read the two Krugman Blogs, he appears to be saying that there is a peripheral possibility that a limited (buy america) protectionism would be good for the world economy. He then says the political problems in the second article would override the benefits. He then talks through criteria which attempt to show that exchange rates which are determined by the world economy to some extent compensate for the trade differences which occur naturally without recourse to protectionism.

Politics as mentioned is really the response of foreign governments to the protectionist measures of the US government - so if america only are allowed to buy American, then the British government would have to compensate by enforcing UK companies to only buy British/French/German etc. would have to respond.
Otherwise the imbalance would be such that funds would be sucked out of the UK/France/Germany etc. to the US. The one sided protectionism would work, if other countries did not have the economic power to respond to the protectionism. This would be the equivalence of a school bully bringing order, by taking everyone elses dinner money...

The result of this would be to get embroiled in a continuous battle to protect more, in order for one country to gain an economic advantage over the other countries.

Unfortunately each country in the world needs each other country for trade of goods that are not produced locally, so the "balance of trade" would be imbalanced. And in fact trade between countries would start to falter, and fail. When you stop trading you start going without, and eventually fighting.

So politics is really the economics of the possible, and also war is politics by other means - when talk doesn't work, and there is no other option for self preservation, then fighting replaces talking.

The preservation of "British jobs for British workers" is one manifestation of protectionism. The worry and the shame is that Portuguese workers have gone home as they now don't feel safe in Britain. Maybe the BNP, as a populist arm of nationalism (fascism), think that's ok, but anyone who doesn't have their head buried in the sand can see this can only lead to bad things.

tomstickland

Generali wrote: »

proper economics as it impacts on Real Life, e.g. what Supply and Demand really are and Ricardo (free trade).

Nobody should be allowed to vote unless they understand what Ricardo had to say.

Do you recommend any books?

Sir_Humphrey

Generali wrote: »

The normal way to rebalance world trade is through the mechanism of floating exchange rates. If you're importing more than you export, your exchange rates will fall until you're back in balance, pretty much. If you export more than you import then the opposite mechanism will apply.

Over the past few years a lot of money has been put the way of speculators and so trade flows have been dwarfed by speculative investments, especially those by Mrs Watanabe investing Japanese household savings into the Carry Trade. The Carry Trade was financed by people borrowing money at very low interest rates in Japan and lending it at higher rates elsewhere.

There is a body of opinion that this is the biggest group buying RMBSs/CDOs etc. I have my doubts but it is perfectly possible.

Now this distorting flow of money has been cut, why not just let trade flows normalise through the usual mechanism of the FX markets? I don't see what could be simpler and less costly than just letting markets find their own level.

If you think Ricardo was wrong then I'd be very interested to understand why in detail. IMO he was possibly the greatest mind of the C19th except Darwin.

As I have made clear, I am generally pro-Free Trade. It is not a question of accepting or not accepting. A mature approach is to look at the merit of the argument, and spot caveats and limitations to a theory. This is essential in assessing economic theories, which have nowhere near the level of empirical proof as natural science theories.

The limitation to Ricardianism is that of most economic argument. Namely the underlying assumptions. Ricardo assumed the immobility of labour, and full employment. Obviously, neither of those assumptions are valid in the 21st Century economy. It also assumes equal opportunity costs and perfect competition, which are never reasonable assumptions IMO. This does not destroy the theory, but restricts its validity.

The other limitation is purely empirical. Where nations such as the UK, Germany and USA have industrialised, it has been through import tariffs, which are then relaxed as the industries matured.

EDIT: To respond to your point in the quotes above, to allow exchange rates to balance trade would help, but in practise, all countries would have to allow this, which is not really likely is it? Can you see China allowing its unemployment to increase without some sort of currency manipulation? They have been doing just that for the last ten years or so! It is a classic prisoners dilemma situation.

Generali

tomstickland wrote: »

Do you recommend any books?

No I don't.

His views are incredibly simple. Look at Wikipedia, it's all you need:

http://en.wikipedia.org/wiki/David_Ricardo

His ideas are beautiful in their simplicity.

purch

The normal way to rebalance world trade is through the mechanism of floating exchange rates

Only works when they float freely.

Generali

Sir_Humphrey wrote: »

As I have made clear, I am generally pro-Free Trade. It is not a question of accepting or not accepting. A mature approach is to look at the merit of the argument, and spot caveats and limitations to a theory. This is essential in assessing economic theories, which have nowhere near the level of empirical proof as natural science theories.

The limitation to Ricardianism is that of most economic argument. Namely the underlying assumptions. Ricardo assumed the immobility of labour, and full employment. Obviously, neither of those assumptions are valid in the 21st Century economy. It also assumes equal opportunity costs and perfect competition, which are never reasonable assumptions IMO. This does not destroy the theory, but restricts its validity.

The other limitation is purely empirical. Where nations such as the UK, Germany and USA have industrialised, it has been through import tariffs, which are then relaxed as the industries matured.

EDIT: To respond to your point in the quotes above, to allow exchange rates to balance trade would help, but in practise, all countries would have to allow this, which is not really likely is it? Can you see China allowing its unemployment to increase without some sort of currency manipulation? They have been doing just that for the last ten years or so! It is a classic prisoners dilemma situation.

What do you think would work?

You describe limited this and manipulated that but don't prescribe or proscribe.

purch wrote: »

Only works when they float freely.

Correct and if we're honest then countries keep kidding themselves that Mercantilism will work when all the evidence show it doesn't. Nor ERM-ism, nor Breton Woods-ism etc............

That people keep making mistakes does mean that we shouldn't keep trying to get it right IMO.

Dylanwing

I would not have put protectionism as a major cause of WW2 - It was more to do with the Versailles Treaty, the collapse of the German economy, and an orator who said what people wanted to hear.
You can look at a lot of factors, the UK has de-regulated it's market and has imported a lot of workers over the last decade - Much of the rest of the EU has protected key industries and restricted movement from Eastern Europe. Reports suggest that this has impacted badly on the British 'working class', it may not be entirely accurate, but that is the popular view. A lot of people are losing their job as Banks pull the plug, in many case, too quickly. Meanwhile, Banks that are insolvent get large bailouts, and if reports of RBS are true, still get huge bonusses.
Look at the response from politicians. Mandelson is a crook, and obsessed with his European dream, Brown just parrots 'Global' 'Started in America' and 'Hard-working families', and Cameron/ Osbourne come across as clueless toffs. It's getting to be a very toxic mix, and I don't see the quality of leadership that is needed to keep people happy. A large number of UK citizens feel disenfranchised, being dictated to by the unelected and unaccountable EU, and totally out of touch Politicians who seem to be working for the wealthy. A breeding ground for blaming outsiders for their plight.
I don't know if Obamas pay cap where taxpayers bail out Companies will work, but it is certainly popular, and Brown could gain a massive boost in support if he did the same. If Politicians don't re-connect with the people, somebody will come along and exploit that.

StevieJ

The problem with US protectionism now would be the psychological damage it would inflict on the world economy in the future, i.e. free trade is great as long as it suits the USA.

Sir_Humphrey

Generali wrote: »

What do you think would work?

You describe limited this and manipulated that but don't prescribe or proscribe.

I am not foolish enough to claim I have a magic, exhaustive plan that will solve all the ills. However, the following gives a rough idea of what I think would be Good Idea.

The economy needs to be tided over in the short term, and restructured to the Scandinavian model in the longer term.

In the short term, massive (much bigger than now) fiscal stimulus is required. Most UK banks need to be nationalised, with the taxpayer getting upside from their eventual recovery. In short, measures have to be taken to ensure lending to viable businesses, and to boost demand.

In the short to medium term, government needs to nurture industries where the UK can be reasonably expected to compete in future, such as green/hi tech. This entails favouring British firms in awarding contracts. The UK infrastructure needs to be radically improved. These need to be funded from greater progressive taxation in the Swedish mould, and reduced waste on private contractors, such as rail operating companies, refuse companies and the suchlike. Tax havens have to be stamped out to prevent leakage of tax revenues.

The economy needs to be tided over in the short term, and restructured to the Scandinavian model in the longer term.

This is of course quite radical. I do not expect that to happen, at least not until the UK has gone through enough pain to finally realise that neo-Liberalism is a busted flush. A change in the priorities of the population away from selfish consumerism to a more rounded idea of the good life is important. Government cannot do that.