The End of Free-Trade Globalization
The world economy is on the brink again, facing a crisis of epic dimensions for reasons largely obscured by the inflamed politics of 2010. Against their wishes, the United States and China have been drawn into an increasingly nasty and dangerous fight over currencies and trade. American politicians, especially desperate Democrats, have framed the conflict in familiar moral terms—a melodrama of America wronged—and demand retaliation. Other nations, sensing the risk of a larger breakdown, have begun to take protective measures. Every man for himself. The center is not holding.
The political fray obscures the fact that the basic economic problem is larger than any single nation and stalks the global trading system itself. There is a huge hole in the world—a massive loss of demand. Think of the trade wars as the largest producers fighting over an abrupt shortage of buyers. Financial collapse and recession, with falling income, defaulting debt and rising unemployment, made the hole. In other times, Washington would have stepped in to impose policy solutions and create market demand as the global system's buyer of last resort. This time, Goliath is gravely weakened, both in economic strength and political authority.
The political push-pull zeroes in on China. Beijing is accused of playing dirty, stealing jobs, production and wealth. Washington imposes a penalty tariff on Chinese tires and tubular steel. Beijing pushes back with a tariff on US poultry. President Obama once again urges China to stop manipulating its currency to underprice Chinese exports and stymie US goods going the other way. China once again blows off his request. United Steelworkers ups the ante by filing a 5,800-page complaint detailing how China is scheming to corner the global market in green technologies. Obama promptly orders an investigation. "What do the Americans want?" asks the vice chair of Beijing's National Development and Reform Commission. "Do they want fair trade? Or an earnest dialogue?... I don't think they want any of this. I think more likely, the Americans just want votes." He has a point. But so do American politicians, who think China's hardball industrial strategy has had something to do with America's anemic recovery. The House, divided on everything else, voted 348-79 in September to authorize tariffs on nearly all Chinese imports if Beijing does not relent in its currency game.
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The US public seems to agree with the harsh stance. A Wall Street Journal poll found that 53 percent (including 61 percent of Tea Party adherents) think free-trade globalization has hurt the US economy. Only 17 percent think it has helped. But the trouble with Americans claiming injured innocence is that it blinds them to the complexities of the predicament. The fact is, the United States and China, motivated by different but mutually reinforcing reasons, collaborated to create the unbalanced trading system. American multinationals eagerly sought access to China's market. The Chinese wanted factories and the modern technologies needed to develop a first-class industrial base. American companies agreed to the basic trade-off: China would let them in to make and sell stuff, and they would share technology and teach Chinese partners how it's done. Not coincidentally, US corporations also gained enormous bargaining power over workers back home by threatening to go abroad for cheaper labor if unions didn't give wage concessions.
Washington blessed the deal. Both parties were convinced decades ago that improving the fortunes of globalizing banks and businesses was in the broad national interest. The Clinton administration capitulated to Chinese negotiators in 2000, admitting China to the World Trade Organization while giving up legal tools that could have controlled China's appetites.
Chinese officials understand, even if many Americans do not, that they are essentially doing what the trading system has allowed or at least tolerated from many others. Washington grumbled when Japan and then South Korea, Taiwan and Singapore pursued similar development strategies. Arrogant US policy-makers assumed that these rivals would eventually adopt the American model and become more like us. They never really have.
The problem is that when a nation of 1.3 billion successfully advances along this road, it blows out the lights. Decades ago, when Washington scolded Japanese officials for violating free-trade orthodoxy, they bowed humbly and made agreeable noises. The Chinese don't bother. They are unabashed because they have always been much more up front about their intentions. In the early 1990s Beijing published a series of directives for major industrial sectors, describing precisely how the state intended to direct the rise of its industrial base. China manipulates its currency—though so do other governments when it serves their interests (indignant senators bash China for depressing its currency, but Washington is doing the very same thing to the dollar through the money spigots of the Federal Reserve). The Chinese also know that Japan suffered years of depressed growth after Washington pushed it into raising the value of its currency. China pirates US intellectual property, and it suppresses wages to attract factories from the United States and elsewhere. It lures major US multinationals by offering tax breaks and subsidies—but it also compels the companies to share their precious technologies with Chinese partners, who are always majority owners.
Which brings us to the present crisis. China's exports exploded toward the end of the Clinton years and expanded even more ferociously under George W. Bush. So did the offloading of US jobs and manufacturing. China's wave of new competition crashed over every industrial economy, but disruptions were most devastating for the United States. American trade deficits soared, peaking at close to 6 percent of GDP in 2006. Imports from China dwarfed exports in sector after sector, including many advanced technological goods developed in America. The goods are often made by US companies, but not here. The US economy has been buying more than it produces—a lot more—and borrowing from foreign creditors, most heavily from China, to do so.
"I admire the Chinese for recognizing the world economy is still a jungle, despite all of its legal trappings," says Alan Tonelson, a conservative trade critic at the US Business and Industrial Council. "But here's the problem. They don't seem to understand that unless the US economy recovers its financial and economic health, the entire world will come crashing down. The reason is, we won't be able to serve any longer as the import sponge that buys from everyone else."
We have reached the endpoint of globalization as we have known it. It cannot continue as before, because the United States is essentially tapped out. Goliath has fallen and cannot get up. Who will lend a hand? Not China, obviously, but also not Japan and the Asian Tigers, or the European nations. All are dealing with their own problems. All but the smallest economies run perennial trade surpluses with the United States. Giving up some of those surpluses means surrendering some portion of domestic growth in order to stabilize the system. No one wants to go first. This is a dangerous impasse, the kind that can easily slip into a general unwinding—that is, depression—if not resolved smartly. "The world is no longer in a common foxhole...but in many different foxholes," observes economist Paul McCulley of PIMCO, the world's largest bond house. Japan and South Korea devalue their currencies to protect their exports (so has the United States). Brazil puts limits on capital inflows to stop foreign money from destabilizing its economy. Currency war is a surrogate for trade war, one of the few levers governments can still manipulate unilaterally.
For Americans the most ominous development is that trade deficits, after shrinking during the recession, are expanding rapidly again. That stands in the way of recovery and helps explain why the federal stimulus of 2009 had less punch than expected. The trap is illustrated by a few recent statistics: the US economy expanded in the second quarter of 2010 by an anemic annualized rate of 1.7 percent. During those same months, however, the nation's trade deficit expanded by 3.5 percent. Do the arithmetic: the US economy would have grown at a much healthier rate if it weren't for its dependence on products made elsewhere. Yet getting different results will take much more than currency adjustments. It means reforming the dynamics of global trade and the US industrial structure, not just the bad habits of American consumers.
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President Obama, unlike his predecessors, understands the problem. He has been trying for the past year to persuade foreign governments to cooperate, with meager results so far. Obama told G-20 leaders in April 2009, "The world has become accustomed to the United States being a voracious consumer market and the engine that drives a lot of economic growth worldwide.... [But] if there's going to be renewed growth, it can't just be the United States as the engine. Everybody is going to have to pick up the pace." At the G-20 meeting this past June, the president was more explicit. "After years of taking on too much debt," he said, "Americans cannot—and will not—borrow and buy the world's way to lasting prosperity. No nation should assume its path to prosperity is simply paved with exports to the United States."
There's no easy road to peace. The target is not only China but some of Washington's old friends, who run bloated surpluses at US expense. The Obama administration pushed concrete measures at the meeting of finance ministers in South Korea in October. Treasury Secretary Tim Geithner proposed a new global rule that would require nations running trade surpluses to shrink them to no more than 4 percent of GDP, presumably by buying more imports from debtor countries, while debtor nations like the United States would have to reduce deficits by the same amount, to less than 4 percent.
Geithner's strict numerical limits were not accepted, but his proposal represents an important first step—a US administration coming to terms with American weakness and stepping away from the free-trade dogma that led to the crisis. The president recognizes the global nature of the problem. But I expect he will be compelled to take a tougher step—acting unilaterally. He will have to act for the United States in ways that get other nations, especially China, to take him seriously. Washington could, for example, declare a financial emergency, enacting legislation to put a ceiling on US trade deficits and begin a gradual process of reducing them. That would be a signal to exporting nations and multinational corporations that the good old days are over.But shrinking the trade deficits, important as it will be, is not sufficient. Washington must also change the rules for how American business and finance operate. Only in America do multinationals get to behave like free riders, with no strings attached. They harvest public money as subsidies and investment capital, they are protected by US armed forces and diplomacy, and they are rescued when they get into trouble. It is a one-way relationship, and the American public knows it.