Economics Essay 59: Protectionism

 Explain the main ways in which countries can protect their domestic industries from foreign competition.

Countries can employ several measures to protect their domestic industries from foreign competition. The main ways in which such protection can be achieved include:

1. Tariffs: Tariffs are taxes imposed on imported goods, making them more expensive compared to domestically produced goods. By levying tariffs, countries can increase the price of imported products, making them less competitive and protecting domestic industries. Tariffs can be specific (a fixed amount per unit) or ad valorem (a percentage of the product's value).

2. Import Quotas: Import quotas place a limit on the quantity of a particular product that can be imported into a country. By restricting the quantity of imports, domestic industries are shielded from foreign competition, ensuring that they have a larger share of the domestic market. Import quotas are often used to protect sensitive industries or to safeguard national security interests.

3. Subsidies: Governments can provide financial assistance or subsidies to domestic industries, making their products more competitive in the market. Subsidies can be in the form of direct payments, tax breaks, or low-cost loans, reducing production costs and enabling domestic industries to offer lower prices or invest in research and development.

4. Regulatory Barriers: Governments can impose regulations, standards, or licensing requirements that foreign producers must meet to enter the domestic market. These regulations may create additional costs and barriers for foreign competitors, providing an advantage to domestic industries that are already compliant.

5. Intellectual Property Protection: Strong intellectual property rights and enforcement mechanisms can safeguard domestic industries by preventing unauthorized use or replication of their proprietary technologies, processes, and inventions. This protection encourages innovation and provides a competitive advantage to domestic firms.

6. Government Procurement Policies: Governments can implement policies that prioritize the purchase of goods and services from domestic suppliers. By giving preference to domestic industries in government procurement contracts, countries can stimulate demand for domestic products and support local businesses.

7. Exchange Rate Manipulation: Governments may manipulate their exchange rates to gain a competitive advantage. By intentionally devaluing their currency, countries can lower the price of their exports, making them more attractive to foreign buyers and potentially reducing the competitiveness of imports.

It is important to note that while these protectionist measures may offer short-term benefits to domestic industries, they can have negative consequences in the long run. They can distort market forces, hinder international trade, and lead to retaliation from trading partners, potentially escalating trade tensions.

Countries often implement protectionist measures to support infant industries, protect national interests, or promote economic development. However, striking a balance between protection and the benefits of open trade is crucial for long-term economic growth and global cooperation.

Why are the rich world’s politicians giving up on economic growth?

 Even when they say they want more prosperity, they act as if they don’t writes The Economist

Dec 14th 2022

The prospect of recession might loom over the global economy today, but the rich world’s difficulties over growth are graver still. The long-run rate of growth has dwindled alarmingly, contributing to problems including stagnant living standards and fulminating populists. Between 1980 and 2000, gdp per person grew at an annual rate of 2.25% on average. Since then the pace of growth has sunk to about 1.1%.

Although much of the slowdown reflects immutable forces such as ageing, some of it can be reversed. The problem is that reviving growth has slid perilously down politicians’ to-do lists. Their election manifestos are less focused on growth than before, and their appetite for reform has vanished.

The latter half of the 20th century was a golden age for growth. After the second world war a baby boom produced a cohort of workers who were better educated than any previous generation and who boosted average productivity as they gained experience. In the 1970s and 1980s women in many rich countries flocked into the workforce. 

The lowering of trade barriers and the integration of Asia into the world economy later led to much more efficient production. Life got better. In 1950 nearly a third of American households were without flush toilets. By 2000 most had at least two cars.

Many of those growth-boosting trends have since stalled or gone into reverse. The skills of the labour force have stopped improving as fast. Ever more workers are retiring, women’s labour-force participation has flattened off and little more is to be gained by expanding basic education. As consumers have become richer, they have spent more of their income on services, for which productivity gains are harder to come by. Sectors like transport, education and construction look much as they did two decades ago. Others, such as university education, housing and health care, are lumbered with red tape and rent-seeking.

Ageing has not just hurt growth directly, it has also made electorates less bothered about gdp. Growth most benefits workers with a career ahead of them, not pensioners on fixed incomes. Our analysis of political manifestos shows that the anti-growth sentiment they contain has surged by about 60% since the 1980s. Welfare states have become focused on providing the elderly with pensions and health care rather than investing in growth-boosting infrastructure or the development of young children. Support for growth-enhancing reforms has withered.

Moreover, even when politicians say they want growth, they act as if they don’t. The twin problems of structural change and political decay are especially apparent in Britain, which since 2007 has managed annual growth in gdp per person averaging just 0.4%. Its failure to build enough houses in its prosperous south-east has hampered productivity, and its exit from the European Union has damaged trade and scared off investment. In September Liz Truss became prime minister by promising to boost growth with deficit-financed tax cuts, but succeeded only in sparking a financial crisis.

Ms Truss fits a broader pattern of failure. President Donald Trump promised 4% annual growth but hindered long-term prosperity by undermining the global trading system. America’s government introduced 12,000 new regulations last year alone. Today’s leaders are the most statist in many decades, and seem to believe that industrial policy, protectionism and bail-outs are the route to economic success. That is partly because of a misguided belief that liberal capitalism or free trade is to blame for the growth slowdown. Sometimes this belief is exacerbated by the fallacy that growth cannot be green.

In fact, demographic decline means that liberal, growth-boosting reforms are more vital than ever. These will not restore the heady rates of the late 20th century. But embracing free trade, loosening building rules, reforming immigration regimes and making tax systems friendly to business investment may add half a percentage point or so to annual per-person growth. That will not put voters in raptures, but today’s growth is so low that every bit of progress matters—and in time will add up to much greater economic strength.

For the time being the West is being made to look good by autocratic China and Russia, which have both inflicted deep economic wounds on themselves. Yet unless they embrace growth, rich democracies will see their economic vitality ebb away and will become weaker on the world stage. Once you start thinking about growth, wrote Robert Lucas, a Nobel-prizewinning economist, “it is hard to think about anything else”. If only governments would take that first step.

Welcome to the era of the bossy state

The relationship between governments and businesses is always changing. After 1945, many countries sought to rebuild society using firms that were state-owned and -managed. By the 1980s, faced with sclerosis in the West, the state retreated to become an umpire overseeing the rules for private firms to compete in a global market—a lesson learned, in a fashion, by the communist bloc. Now a new and turbulent phase is under way, as citizens demand action on problems, from social justice to the climate. In response, governments are directing firms to make society safer and fairer, but without controlling their shares or their boards. Instead of being the owner or umpire, the state has become the backseat driver. This bossy business interventionism is well-intentioned. But, ultimately, it is a mistake.
 
Signs of this approach are everywhere, as our special report explains. President Joe Biden is pursuing an agenda of soft protectionism, industrial subsidies and righteous regulation, aimed at making the home of free markets safe for the middle classes. In China Xi Jinping’s “Common Prosperity” crackdown is designed to curb the excesses of its freewheeling boom, and create a business scene that is more self-sufficient, tame and obedient. The European Union is drifting away from free markets to embrace industrial policy and “strategic autonomy”. As the biggest economies pivot, so do medium-sized ones such as Britain, India and Mexico. Crucially, in most democracies, the lure of intervention is bipartisan. Few politicians fancy fighting an election on a platform of open borders and free markets.

That is because many citizens fear that markets and their umpires are not up to the job. The financial crisis and slow recovery amplified anger about inequality. Other concerns are more recent. The world’s ten biggest tech companies are over twice as big as they were five years ago and sometimes seem to behave as if they are above the law. The geopolitical backdrop is a far cry from the 1990s, when the expansion of trade and democracy promised to go hand in hand, and from the cold war when the West and the Soviet Union had few business links. Now the West and totalitarian China are rivals but economically intertwined. Gummed-up supply chains are causing inflation, reinforcing the perception that globalisation is overextended. And climate change is an ever more pressing threat.

Governments are redesigning global capitalism to deal with these fears. But few politicians or voters want to go back to full-scale nationalisation. Not even Mr Xi is keen to reconstruct an empire of iron and steel plants run by chain-smoking commissars, while Mr Biden, despite his nostalgia for the 1960s, need only walk through America’s clogged West Coast ports to recall that public ownership can be shambolic. At the same time the pandemic has seen governments experiment with new policies that were unimaginable in December 2019, from perhaps $5trn or more of handouts and guarantees for firms to indicative guidance on optimal spacing of customers in shopping aisles.

This opening of the interventionist mind is coalescing around policies that fall short of ownership. One set of measures claims to enhance security, broadly defined. The class of industries in which government direction is legitimate on security grounds has expanded beyond defence to include energy and technology. In these areas governments are acting as de facto central planners, with research and development (r&d) spending to foster indigenous innovation and subsidies to redirect capital spending. In semiconductors America has proposed a $52bn subsidy scheme, one reason why Intel’s investment is forecast to double compared with five years ago. China is seeking self-sufficiency in semiconductors and Europe in batteries.

The definition of what is seen as strategic may well expand further to include vaccines, medical ingredients and minerals, for example. In the name of security, most big countries have tightened rules that screen incoming foreign investment. America’s mesh of punitive sanctions and technology export controls encompasses thousands of foreign individuals and firms.

The other set of measures aims to enhance stakeholderism. Shareholders and consumers no longer have uncontested primacy in the hierarchy of groups that firms serve. Managers must weigh the welfare of other constituents more heavily, including staff, suppliers and even competitors. The most visible part of this is voluntary, in the form of “esg” investing codes that score firms for, say, protecting biodiversity, local people or their own workers. But these wider obligations may become harder for firms to avoid. In China Alibaba has pledged a $15bn “donation” to the Common Prosperity cause. In the West stakeholderism may be enforced through the bureaucracy. Central banks and public pension funds may shun the securities of firms judged to be anti-social. America’s antitrust agency, which once safeguarded consumers alone, is mulling other aims such as helping small firms.

The ambition to confront economic and social problems is admirable. And so far, outside China at least, bossier government has not hurt business confidence. America’s main stockmarket index is over 40% higher than it was before the pandemic, while capital spending by the world’s largest 500-odd listed firms is up by 11%. Yet, in the longer term, three dangers loom.
High stakes

The first is that the state and business, faced by conflicting aims, will fail to find the best trade-offs. A fossil-fuel firm obliged to preserve good labour relations and jobs may be reluctant to shrink, hurting the climate. An antitrust policy that helps hundreds of thousands of small suppliers will hurt tens of millions of consumers who will end up paying higher prices. Boycotting China for its human-rights abuses might deprive the West of cheap supplies of solar technologies. Businesses and regulators focused on a single sector are often ill-equipped to cope with these dilemmas, and lack the democratic legitimacy to do so.

Diminished efficiency and innovation is the second danger. Duplicating global supply chains is extraordinarily expensive: multinational firms have $41trn of cross-border investments. More pernicious in the long run is a weakening of competition. Firms that gorge on subsidies become flabby, whereas those that are protected from foreign competition are more likely to treat customers shabbily. If you want to rein in Facebook, the most credible challenger is TikTok, from China. An economy in which politicians and big business manage the flow of subsidies according to orthodox thinking is not one in which entrepreneurs flourish.

The last problem is cronyism, which ends up contaminating business and politics alike. Firms seek advantage by attempting to manipulate government: already in America the boundary is blurred, with more corporate meddling in the electoral process. Meanwhile politicians and officials end up favouring particular firms, having sunk money and their hopes into them. The urge to intervene to soften every shock is habit-forming. In the past six weeks Britain, Germany and India have spent $7bn propping up two energy firms and a telecoms operator whose problems have nothing to do with the pandemic.

This newspaper believes that the state should intervene to make markets work better, through, for example, carbon taxes to shift capital towards climate-friendly technologies; r&d to fund science that firms will not; and a benefits system that protects workers and the poor. But the new style of bossy government goes far beyond this. Its adherents hope for prosperity, fairness and security. They are more likely to end up with inefficiency, vested interests and insularity.

US-China rivalry drives the retreat of market economics

Gideon Rachman in The FT 

Old ideas are like old clothes — wait long enough and they will come back into fashion. Thirty years ago, “industrial policy” was about as fashionable as a bowler hat. But now governments all over the world, from Washington to Beijing and New Delhi to London, are rediscovering the joy of subsidies and singing the praises of economic self-reliance and “strategic” investment. 

The significance of this development goes well beyond economics. The international embrace of free markets and globalisation in the 1990s went hand in hand with declining geopolitical tension. The cold war was over and governments were competing to attract investment rather than to dominate territory. 

Now the resurgence of geopolitical rivalry is driving the new fashion for state intervention in the economy. As trust declines between the US and China, so each has begun to see reliance on the other for any vital commodity — whether semiconductors or rare-earth minerals — as a dangerous vulnerability. Domestic production and security of supply are the new watchwords. 

As the economic and industrial struggle intensifies, the US has banned the exports of key technologies to China and pushed to repatriate supply chains. It is also moving towards direct state-funding of semiconductor manufacturing. For its part, China has adopted a “dual circulation” economy policy that emphasises domestic demand and the achievement of “major breakthroughs in key technologies”. The government of Xi Jinping is also tightening state control over the tech sector. 

The logic of an arms race is setting in, as each side justifies its moves towards protectionism as a response to actions by the other side. In Washington, the US-China Strategic Competition Act, currently wending its way through Congress, accuses China of pursuing “state-led mercantilist economic policies” and industrial espionage. The announcement in 2015 of Beijing’s “Made in China 2025” industrial strategy is often cited as a turning point. In Beijing, by contrast, it is argued that a fading America has turned against globalisation in an effort to block China’s rise. President Xi has said the backlash against globalisation in the west means China must become more self-reliant. 

The new emphasis on industrial strategy is not confined to the US and China. In India, Narendra Modi’s government is promoting a policy of Atmanirbhar Bharat (self-reliant India), which encourages domestic production of key commodities. The EU published a paper on industrial strategy last year, which is seen as part of a drive towards strategic autonomy and less reliance on the outside world. Ursula von der Leyen, European Commission president, has called for Europe to have “mastery and ownership of key technologies”. 

Even a Conservative administration in Britain is turning away from the laissez-faire economics championed by former prime minister Margaret Thatcher, and seeking to protect strategic industries. The government is reviewing whether to block the sale of Arm, a UK chipmaker, to Nvidia, a US company. The UK government has also bought a controlling stake in a failing satellite business, OneWeb. 

Covid-19 has strengthened the fashion for industrial policy. The domestic production of vaccines is increasingly seen as a vital national interest. Even as they decry “vaccine nationalism” elsewhere, many governments have moved to restrict exports and to build up domestic suppliers. The lessons about national resilience learnt from the pandemic may now be applied to other areas, from energy to food supplies. 

In the US, national security arguments for industrial policy are meshing with the wider backlash against globalisation and free trade. Joe Biden’s rhetoric is frankly protectionist. The president proclaimed to Congress: “All the investments in the American jobs plan will be guided by one principle: Buy American.” 

In an article last year, Jake Sullivan, Mr Biden’s national security adviser, urged the security establishment to “move beyond the prevailing neoliberal economic philosophy of the past 40 years” and to accept that “industrial policy is deeply American”. The US, he argued, will continue to lose ground to China on key technologies such as 5G and solar panels, “if Washington continues to rely so heavily on private sector research and development”. 

Many of these arguments will sound like common sense to voters. Protectionism and state intervention often does. But free-market economists are aghast. Swaminathan Aiyar, a prominent commentator in India, laments the return of the failed ideas of the past, arguing that: “Self sufficiency was what Nehru and Indira Gandhi tried in the 1960s and 1970s. It was a horrible and terrible flop.” Adam Posen, president of the Peterson Institute for International Economics in Washington, recently decried “America’s self-defeating economic retreat”, arguing that policies aimed at propping up chosen industries or regions usually end in costly failure. 

As tensions rise between China, the US and other major powers, it is understandable that these countries will look at the security implications of key technologies. But claims by politicians that industrial policy will also produce better-paying jobs and a more productive economy deserve to be treated with deep scepticism. Sometimes ideas go out of fashion for a reason.

Are poor countries poor because of their poor people? Economic History in Small Doses 5

Girish Menon*

A bus driver in Mumbai gets paid around Rs.50 per hour whereas his equivalent in Cambridge gets paid £12 per hour. Using currency exchange rates, the Cambridge driver gets paid 24 times more than his Indian equivalent. Does that mean John the Cambridge driver is 24 times more productive than Om? If anything, Om would likely be a much more skilled driver than John because Om has to negotiate his way through bullock carts, rickshaws, bicycles and cows on the street.

The main reason why John is paid 24 times more than Om is because of protectionism. Some, British workers are protected from competition from workers in India, and soon from the EU, through immigration control.  (Technology has erased this protectionism in the relocation of many white collar jobs.) This form of protectionism goes unmentioned in the WTO (World Trade Organization) as countries raise their barriers to immigration of poor workers.

 Many people think that poor countries are poor because of their poor people. The rich people in poor countries typically blame their countries’ poverty on the ignorance, laziness and passivity of the poor. Arithmetically too, it is true that poor people pull down the national income average because of their large numbers.

 Little do the rich people in poor countries realize that their countries are poor not because of the poor but because of themselves. The primary reason why John is paid 24 times more than Om is because John works in a labour market with other people who are way more than 24 times more productive than their Indian counterparts. The top managers, scientists and engineers in the UK are hundreds of times more productive than their Indian equivalents, so the UK’s national productivity ends up being in the region of 24 times that of India.

In other words, poor people from poor countries are usually able to hold their own against counterparts in rich countries. It is the rich from the poor countries who cannot do that. It is their relative low productivity that makes their country poor. So, instead of blaming their own poor for dragging the country down, the rich of the poor countries should ask themselves why they cannot pull up the productivity and innovation in their own country,

Of course, the rich in rich countries need not get smug. They are beneficiaries of economies with better technology, better organized firms, better institutions and better physical infrastructure. Warren Buffet expressed it best:

 “I personally think that society is responsible for a very significant percentage of what I’ve earned. If you stick me down in the middle of Bangladesh or Peru or someplace, you’ll find out how much this talent is going to produce in the wrong kind of soil. I will be struggling thirty years later. I work in a system that happens to reward what I do well – disproportionately well.”

 

* Adapted from 23 Things they don’t tell you about Capitalism by Ha Joon Chang

Ideological Positions and Economic History

 

My response to Shekhar Gupta's video

Dear Mr. Gupta

I believe your thesis on economic history is flawed when you argue that Japan, Korea, Taiwan and Singapore have grown because of economic freedoms i.e. I presume you mean free market practices. I have often heard you say that India too should follow free market practices to achieve similar heights. In the above process the elephant in the room i.e. how China rose with state intervention, has also been ignored.

Kindly permit me to state a few historical facts extracted from 'Bad Samaritans The Guilty Secrets of Rich Nations...' by Ha Joon Chang

1.  When Robert Walpole became the British Prime Minister in 1721 he launched a Swadeshi* policy aimed to protect British manufacturing industries from foreign competition, subsidise them and encourage them to export. Tariffs on imported foreign manufactured goods were significantly raised while tariffs on raw materials were lowered. Regulation was introduced to control the quality of manufactured goods so that unscrupulous manufacturers could not damage the reputation of British products in foreign markets. Walpole’s protectionist policies remained in place for the next century, helping British manufacturing industries catch up with and then finally forge ahead of the counterparts on the Continent.By the end of the Napoleonic wars in 1815 British manufacturers were firmly established as the most efficient in the world and it was then that they started campaigning for free trade.

2. The US too followed similar protectionist policies, espoused by Alexander Hamilton, which included protective tariffs, import bans, subsidies, export ban on key raw materials, financial aid...until the end of the Second World War (WWII). It was only after WWII, with its industrial supremacy unchallenged, that the US started championing the cause of free trade. Even when it shifted to freer trade, the US government promoted key industries by another means; namely public funding of Research and Development (R&D). Without government funding for R&D the US  would not have been able to maintain its technological lead over the rest of the world on key industries like computers, semiconductors, life sciences, the internet and aerospace.

3. In Japan the famous MITI (Ministry of International Trade and Industry) orchestrated an industrial development programme that has now become a legend. After WWII, imports were tightly controlled through government control of foreign exchange. Exports were promoted in order to maximize the supply of foreign currency needed to buy up better technology. This involved direct and indirect export subsidies as well as information and marketing help from JETRO the state’s trading agency.

4. Even Korea has not been an exception to this pattern. The Korean miracle was the result of a clever and pragmatic mixture of market incentives and state direction. The Korean government did not have blind faith in the free market either. While it took markets seriously, the Korean strategy recognized that they often need to be corrected through policy intervention.

5. Singapore has had free trade and relied heavily on foreign investment, but even so, it does not conform in other respects to the neo-liberal ideal. It used considerable subsidies to MNCs in industries it considered strategic. It also has one of the largest state owned enterprises which supplies housing and almost all land is owned by the government.

To conclude, I feel that Mr. Gupta’s advocacy of free markets is based on a fundamentally defective understanding of the forces driving globalisation and a distortion of history to fit the theory. Free markets and trade was often imposed on rather than chosen by weaker countries. Virtually all successful economies, developed and developing, got where they are through selective strategic integration with the world economy rather than unconditional  global integration.

Regards

Girish Menon

* Swadeshi  is a conjunction of two Sanskrit words: swa ("self" or "own") and desh ("country"). Swadeshi is an adjective which means "of one's own country".

Elected representatives will do the right thing on Brexit

Nick Clegg in The Financial Times


Like the suspense in an old-fashioned cowboy film before the final gunfight, tension in Westminster is already rising as MPs prepare for the “meaningful” vote on Brexit towards the end of this year. The upcoming debates in the House of Commons will be the political equivalent of scuffles in a saloon, harbingers of the real showdown to come. 

Many MPs — the majority of whom would probably slip the noose of Brexit if only they knew how — are still waiting, hoping, that something might turn up. Perhaps public opinion will shift decisively against Brexit before the vote? Maybe the economic damage will suddenly become more obvious? Or could the gory details of the Brexit deal itself prompt people to think again? 

The truth, alas, is much harsher. Public opinion has shifted a little in favour of the Remain camp, and a lot towards wider concern about the impact of Brexit on the NHS and the economy. But it remains firmly enveloped in an indifference towards the details of the negotiations, and a sullen belief that politicians should just “get on with it”. Advertising campaigns by anti-Brexit groups will not, on their own, shift opinion in a big way. 

Equally, while there are abundant signs that Brexit has already had a chilling effect on economic growth, it has not (yet) done so in a dramatic enough fashion to force a rethink. And those who hope for a level of unforgiving detail in the Brexit deal will hope in vain: there is a shared interest between David Davis and Michel Barnier not to scare the horses, either in Westminster or the European Parliament, before the definitive votes this winter. They both want a deal, and both are happy to delay the really tricky choices about the future EU-UK relationship until after parliamentarians can do anything about it. 

So MPs will have nowhere to hide. They are unlikely to be rescued by last minute developments. They will be left alone with their own consciences. And this is exactly as it should be: the vote on the government’s Brexit deal will be like no other in recent history, touching on every vital economic, security and constitutional feature of our country. That is why John Major was right to call for a free vote for MPs, and to suggest that, in the absence of an unwhipped vote, MPs should put the final deal to another vote of the people instead. 

As MPs limber up to make their choice, they can at least be sure of one thing: all of the reasons which (they will be told) oblige them to support the deal will be false. Some newspapers will screech that a vote against the deal is a vote to put Jeremy Corbyn into Downing Street, when in truth the Fixed Term Parliament Act protects the government from an instant election. 

Commentators will opine that without a deal the UK will crash out of the EU on March 29 next year, when it is obvious that the EU27 would give the UK more time. And the repeated allegation that a vote to withhold parliamentary consent would “defy the will of the people” ignores the fact that the version of Brexit presented to MPs will be utterly different to the version promised to voters, and that the world has changed dramatically since 2016. 

The notion, for instance, that MPs should not be allowed to take into account America’s lurch to protectionism under President Donald Trump when assessing the best way forward is absurd. One of the greatest hallmarks of a healthy democracy, as opposed to rigid ideological regimes, is an ability to adapt in the face of changing circumstances. Democracies self-correct in a way which theocracies and authoritarian systems cannot. To deny MPs the right to make such judgments is an abrogation of democracy. 

In the end, it comes down to a judgment by our elected representatives to do what they believe to be best for those they serve. Given the universal cynicism with which politicians are viewed, my hunch is that this is one bit of the Brexit jigsaw which is too readily overlooked. In the end, most MPs, most of the time, want to do the right thing.

Columbus shows Trump how to thrive in the new world order

Rana Foroohar in The Financial Times


A day or two after Donald Trump announced tariffs on a spate of Chinese goods, the world was gripped by fears of a trade war. More than a week later, there is a storyline building that perhaps the US president had the right idea. China is negotiating with the US; the US and South Korea will probably cut a new trade deal. While the administration is right to call China out over unfair trade practices, however, there is also a risk of taking away the wrong message, which is that tariffs are the best way to protect the US Rust Belt. 

China may not play fair, but it plays the long game. This is the crucial point. While Mr Trump rails mostly against the trade deficit, China has an industrial policy designed to win the jobs of the future in strategic high-tech industries. This is the better strategy, as evidenced not only by what is happening in the Middle Kingdom, but also in the US. 

Consider the success of Columbus, Ohio, a city whose fortunes I have followed closely for many years because it is an economic and political bellwether for the country. Politicos come here to take the pre-election temperature of the nation and companies to test drive new products. Columbus is in the heart of the Rust Belt territory that helped elect the president. Mr Trump has visited Ohio in recent days, offering modest federal incentives with the aim of creating a boom in local infrastructure spending (unlikely, given the dismal fiscal picture in many US states and cities). 

Columbus is the third-biggest national market for employment in the manufacture of motor vehicles. Yet the city fathers are not too bothered either way about what the president does or does not do around tariffs. 

“Some industries will win, some will lose,” says Kenny McDonald, the head of Columbus 2020, the regional economic development strategy. “But there’s plenty of people at JPMorgan, Honda and Nationwide [all large local employers] that are right now working on algorithms that may replace their jobs.” 

This statement reflects important truths. During the past four decades, technology has created just as much job disruption, if not more, in the Rust Belt as has trade. After the global financial crisis, Columbus was one of the US cities that suffered most. While it didn’t fall quite as far as the rest of the state thanks to a diversified economy (Columbus is the state capital and also has a strong education sector), it was faced with chopping $100m in municipal spending — more than 15 per cent of its total operating budget — in 2009. 

The city did all the usual back-end trimming of public services. But then, rather than become Detroit, which for a period of time literally couldn’t keep the lights or water on, Columbus also did something else: it thought ahead. 

The Democratic mayor went to the Republican city fathers and persuaded them to support a tax rise, the first in nearly four decades. They agreed, on condition that a chunk of that money would go into a public-private economic development partnership that focused on how to cultivate human capital for an era in which all value will reside in intellectual property, data and ideas. 

They connected community colleges with local companies, domestic and global (L Brands, JPMorgan, Worthington Industries, Honda) to train up a digitally savvy technical workforce. They renovated the crumbling downtown and created new housing stock to appeal to the millennials who had been leaving for greener pastures after their studies. 

Columbus is now one of the top 10 areas that young workers are pouring into (it ranks number three as a city of choice for fashion designers, after Los Angeles and New York). In an effort to move from making bumpers and hubcaps to being part of the internet of things, Columbus bid for, and won, a $40m Department of Transportation grant to become a “smart city” focused on electric vehicles. About $500m of additional investment has followed. 

“This isn’t a five-year plan for economic development, it’s a 100-year plan,” says Alex Fischer, head of the chief executives group the Columbus Partnership. 

The city is part of Elon Musk’s “hyper-loop” plan to create a train that can connect Chicago, Columbus and Pittsburgh in minutes. Ohio State and Columbus State Community College have started some of the first degree programmes in data analytics. Tesla, AWS and Apple have moved into town. Accenture now has an innovation lab on what used to be the site of a large buggy manufacturer. 

It is hard to imagine a greater symbol of change. The Columbus region has, since 2010, created roughly half of all the new jobs in Ohio. Harvard Business School recently wrote a case study about the city’s accomplishments. 

The city’s success is a great example of what American industrial policy can yield. Many countries — not just China, but also a number of European nations — create multiyear plans for economic development. The US does not, of course. Industrial policy have always been dirty words here. 

Mr Trump, and many others, rail against Chinese state-run capitalism. But by demonising the outsider, rather than creating a real national economic development strategy at home, the US is missing the point. Columbus is, in a way, showing how to do Chinese economic development with American characteristics. It’s a strategy worth copying.

Populism is the result of global economic failure

Larry Elliott in The Guardian


The rise of populism has rattled the global political establishment. Brexit came as a shock, as did the victory of Donald Trump. Much head-scratching has resulted as leaders seek to work out why large chunks of their electorates are so cross.

The answer seems pretty simple. Populism is the result of economic failure. The 10 years since the financial crisis have shown that the system of economic governance that has held sway for the past four decades is broken. Some call this approach neoliberalism. Perhaps a better description would be unpopulism.

Unpopulism meant tilting the balance of power in the workplace in favour of management and treating people like wage slaves. Unpopulism was rigged to ensure that the fruits of growth went to the few not to the many. Unpopulism decreed that those responsible for the global financial crisis got away with it while those who were innocent bore the brunt of austerity.
Anybody seeking to understand why Trump won the US presidential election should take a look at what has been happening to the division of the economic spoils. The share of national income that went to the bottom 90% of the population held steady at around 66% from 1950 to 1980. It then began a steep decline, falling to just over 50% when the financial crisis broke in 2007.

Similarly, it is no longer the case that everybody benefits when the US economy is doing well. During the business cycle upswing between 1961 and 1969, the bottom 90% of Americans took 67% of the income gains. During the Reagan expansion two decades later they took 20%. During the Greenspan housing bubble of 2001 to 2007, they got just two cents in every extra dollar of national income generated while the richest 10% took the rest.


Those responsible for global financial crisis got away with it while those who were innocent bore the brunt of austerity

The US economist Thomas Palley* says that up until the late 1970s countries operated a virtuous circle growth model in which wages were the engine of demand growth.

“Productivity growth drove wage growth which fueled demand growth. That promoted full employment which provided the incentive to invest, which drove further productivity growth,” he says.

Unpopulism was touted as the antidote to the supposedly-failed policies of the post-war era. It promised higher growth rates, higher investment rates, higher productivity rates and a trickle down of income from rich to poor. It has delivered none of these things.

James Montier and Philip Pilkington of the global investment firm GMO say that the system that arose in the 1970s was characterised by four significant economic policies: the abandonment of full employment and its replacement with inflation targeting; an increase in the globalisation of the flows of people, capital and trade; a focus on shareholder maximisation rather than reinvestment and growth; and the pursuit of flexible labour markets and the disruption of trade unions and workers’ organisations.

To take just the last of these four pillars, the idea was that trade unions and minimum wages were impediments to an efficient labour market. Collective bargaining and statutory pay floors would result in workers being paid more than the market rate, with the result that unemployment would inevitably rise.

Unpopulism decreed that the real value of the US minimum wage should be eroded. But unemployment is higher than it was when the minimum wage was worth more. Nor is there any correlation between trade union membership and unemployment. If anything, international comparisons suggest that those countries with higher trade union density have lower jobless rates. The countries that have higher minimum wages do not have higher unemployment rates.

“Labour market flexibility may sound appealing, but it is based on a theory that runs completely counter to all the evidence we have,” Montier and Pilkington note. “The alternative theory suggests that labour market flexibility is by no means desirable as it results in an economy with a bias to stagnate that can only maintain high rates of employment and economic growth through debt-fuelled bubbles that inevitably blow up, leading to the economy tipping back into stagnation.”

This quest for ever-greater labour-market flexibility has had some unexpected consequences. The bill in the UK for tax credits spiralled quickly once firms realised that they could pay poverty wages and let the state pick up the bill. Access to a global pool of low-cost labour meant there was less of an incentive to invest in productivity-enhancing equipment.

The abysmally-low levels of productivity growth since the crisis have encouraged the belief that this is a recent phenomenon, but as Andy Haldane, the Bank of England’s chief economist, noted last week, the trend started in most advanced countries in the 1970s.

“Certainly, the productivity puzzle is not something which has emerged since the global financial crisis, though it seems to have amplified pre-existing trends,” Haldane said.


Bolshie trade unions certainly can’t be blamed for Britain’s lost productivity decade. The orthodox view in the 1970s was that attempts to make the UK more efficient were being thwarted by shop stewards who modeled themselves on Fred Kite, the character played by Peter Sellers in I’m Alright Jack. Haldane puts the blame elsewhere: on poor management, which has left the UK with a big gap between frontier firms and a long tail of laggards. “Firms which export have systematically higher levels of productivity than domestically-oriented firms, on average by around a third. The same is true, even more dramatically, for foreign-owned firms. Their average productivity is twice that of domestically-oriented firms.”

Wolfgang Streeck: the German economist calling time on capitalism

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Populism is seen as irrational and reprehensible. It is neither. It seems entirely rational for the bottom 90% of the US population to question why they are getting only 2% of income gains. It hardly seems strange that workers in Britain should complain at the weakest decade for real wage growth since the Napoleonic wars.

It has also become clear that ultra-low interest rates and quantitative easing are merely sticking-plaster solutions. Populism stems from a sense that the economic system is not working, which it clearly isn’t. In any other walk of life, a failed experiment results in change. Drugs that are supposed to provide miracle cures but are proved not to work are quickly abandoned. Businesses that insist on continuing to produce goods that consumers don’t like go bust. That’s how progress happens.

The good news is that the casting around for new ideas has begun. Trump has advocated protectionism. Theresa May is consulting on an industrial strategy. Montier and Pilkington suggest a commitment to full employment, job guarantees, re-industrialisation and a stronger role for trade unions. The bad news is that time is running short. More and more people are noticing that the emperor has no clothes.

Even if the polls are right this time and Marine Le Pen fails to win the French presidency, a full-scale political revolt is only another deep recession away. And that’s easy enough to envisage.

The Humbug of Finance

Prabhat Patnaik in The Economic and Political Weekly


The renowned economist Joan Robinson (1962) had referred to the view that the government’s budget should always be balanced, as the “humbug of finance,” namely, as a false proposition with no theoretical merit which was nonetheless promoted by finance capital. These days, of course, the insistence is not exactly on balancing the budget as was the case during the pre-second world war years. A certain amount of fiscal deficit relative to gross domestic product (GDP), usually 3%, is considered “permissible,” though it is not clear what is so sacrosanct about the figure 3 and why 3 is better than zero. But this shift from zero to 3% does not signify any change in theoretical position: it still invokes the same logic that underlay the insistence on balancing the budget. In Robinson’s words, it still constitutes “the humbug of finance,” though with a slightly, and inexplicably, different number for the percentage of fiscal deficit to the GDP.

The argument which the insistence on balancing the budget advances is that a fiscal deficit “crowds out” private investment. Now, for this to happen there must be a fixity of supply of some economic variable, so that the government taking more of it (via a fiscal deficit) leaves less for the private sector. What exactly is this variable? Pre-Keynesian theory believed that this given variable (assuming for simplicity, a closed economy) was the magnitude of “savings”: a fiscal deficit, by drawing more “savings” towards the government would leave less “savings” for the private sector, and hence reduce private investment via a rise in the interest rate. (Even if the rise in the interest rate itself contributed towards an increase in “savings” so that their magnitude was not exactly fixed, this would still mean a partial crowding out of private investment because of the rise in the interest rate.)

This argument, however, was obviously false, since “savings” depended not just on the interest rate but also upon the level of income (and on the distribution of income too, though we shall not go into the question of distribution of income here). Since a fiscal deficit in an economy that was demand-constrained—namely, had unemployed labour and unutilised capacity—raised the level of income, it also increased “savings.” In fact at any given interest rate (as Richard Kahn’s famous proposition on the multiplier showed), a fiscal deficit (in a closed economy) generated an amount of private “savings” in excess of private investment that was exactly equal to itself. Hence private investment did not get “crowded out;” additional private savings got generated. And to believe otherwise was to subscribe to Say’s Law—that there could never be a deficiency of aggregate demand—which was absurd.

The other economic variable whose fixity is invoked these days to argue the “crowding out” proposition (since none can seriously profess a belief in Say’s Law today) is money supply. A rise in the fiscal deficit raises income; but, if money supply is fixed, then the interest rate rises which “crowds out” private investment. But, even leaving aside the fact of the endogeneity of money supply—namely, the fact that in a modern economy money supply simply adjusts to the demand for it at a given interest rate—and accepting this assertion for argument’s sake, such a situation can only arise if a government that is pursuing an expansionary fiscal policy is simultaneously pursuing a tight monetary policy. This is a mistake in policy and not any inherent flaw of the fiscal deficit itself.
There is therefore no logical reason why in a situation of deficiency of aggregate demand the government should not resort to a fiscal deficit to boost demand and hence output and employment.1 To be sure, a fiscal deficit is not the best way to finance larger government expenditure for stimulating demand in such a situation. Larger government expenditure financed by a tax on profits even within a balanced budget is better than a fiscal deficit for overcoming a deficiency of aggregate demand, for one obvious reason, namely, that it keeps down wealth inequality. Since a fiscal deficit generates an amount of private savings in excess of private investment exactly equal to itself, taxing away this excess rather than leaving it in the hands of capitalists, who are primarily the savers, keeps down wealth inequality (as savings constitute addition to wealth). But increasing government expenditure financed by a fiscal deficit is better than keeping down government expenditure and balancing the budget, as the “humbug of finance” would advocate.

A new consideration however intrudes here. Even though there may be nothing wrong with a fiscal deficit, and the view that the budget must be balanced (or nearly balanced with at most a 3% fiscal deficit) is no more than the “humbug of finance,” since finance capital does not like fiscal deficits, whatever the reason, in an economy open to cross-border financial flows, running such a deficit would lead to an outflow of finance that is obviously harmful to the economy. Hence the fiscal deficit has to be controlled, even though the arguments advanced for doing so are wrong, simply in deference to the caprices of globalised finance. Let us explore the implications of this argument a little further.

Opposition to State Intervention

The basic proposition established by the Keynesian Revolution was that in a capitalist economy, where all economic agents acted “rationally” in the sense of maximising some objective function subject to certain constraints that are given, the overall outcome could be socially “irrational” in an obvious sense, namely, that it could be characterised by both unemployment and unutilised capacity. In such a case, the outcome, quite apart from the fact that it did not satisfy Pareto-optimality, would not even satisfy private “rationality.”

What Keynes suggested, therefore, was that the state should intervene in the economy in order to realise social rationality, in the sense of an avoidance of what he called a state of “involuntary unemployment.” Implicit in this suggestion was the assumption that the state itself was free to act according to its own wisdom, unconstrained by the demands or pressures from any agency acting in accordance with its private rationality. The state, in other words, could fulfil its role of being an agency for realising social rationality only if it was external to the world of private rationality and was unconstrained by, and non-imitative of, the agents belonging to this world. (The Marxist critique of Keynesianism argued that this was not possible, but let us leave this aside for the present.)

The state’s being non-imitative of private agents, which is an obvious condition for its intervening successfully to achieve social rationality (for otherwise it will simply replicate the same result that is achieved through the mere agglomeration of private decisions), implies a fundamental break from a certain analogy that is often drawn. This analogy states that just as an individual cannot go on accumulating debt, likewise, the state too cannot simply go on piling up debt; that the state too has to tighten its belt in order to ensure that it does not fall irredeemably into debt. This analogy is doubly wrong: it is wrong in the sense that the state, because it has sovereign powers of taxation, is on a different footing from individuals; and it is also wrong in the sense that if the state acted like any individual does, then it would be incapable of achieving social rationality by overcoming the deficiency of aggregate demand.

Forcing the state to bow to the caprices of globalised finance, by making it “fiscally responsible” (namely, by keeping it within a fiscal deficit ceiling), makes it constrained by private rationality, and hence prevents it from being an instrument for the achievement of social rationality. Fiscal responsibility legislation enacted by the state, to which the state adheres, amounts therefore, to robbing capitalism of any means of achieving social rationality, particularly in the sense of overcoming “involuntary unemployment.”

The question immediately arises: since overcoming “involuntary unemployment” represents a Pareto-improvement in the sense that everybody stands to gain from it—the capitalists through obtaining higher profits and the workers through obtaining higher employment (and hence incomes)—why should finance capital be opposed to state intervention by fiscal means which serves this end? This opposition incidentally is not something that arises only in the age of globalised finance, it existed even before finance capital became globalised. The globalisation of finance only means that the demands of finance necessarily get accepted by the nation state, for fear that otherwise there would be a capital flight; but the demand for “sound finance” itself is characteristic of finance capital per se. This is the reason why Keynes’ proposal in 1929, put forward by Lloyd George, the leader of the Liberal Party to which Keynes belonged, for a scheme of public works financed by a fiscal deficit to alleviate unemployment in Britain, was turned down by the British Treasury under pressure from the City of London, the seat of British finance capital. The question therefore is, why is finance capital so opposed to fiscal deficits even when there are no palpable ill-effects of such deficits, other than those that might be caused by its own opposition to them?

The answer, I believe, lies in the fact that accepting the need for intervention by an agency entrusted with upholding “social rationality” undermines the social legitimacy of the economic system presided over by finance capital. Any demonstration that the universal pursuit of private rationality, which is what capitalism entails, leads to a socially irrational outcome, subverts the power of financial interests, which is why they vehemently deny the need for such direct state intervention. They would rather have the state intervening by creating a better situation for the play of private rationality. In short, indirect instead of direct intervention, or jogging private rationality instead of acting independently of it, is what they prefer.

Monetary policy is the pre-eminent means for such indirect intervention, apart of course from other means like guaranteed rates of return, tax concessions to the capitalists (which also enlarge the fiscal deficit but which are not frowned upon by them). Monetary policy acts through inducing the capitalists to invest more (or generally through making the affluent who constitute the “creditworthy” segment of the population to spend more). Changes in monetary policy as the means of overcoming “involuntary unemployment” do not give the impression of there being something intrinsically wrong with the system; they rather give the impression of creating the right atmosphere for its smooth functioning.

Indeed a focus on monetary policy goes much further; it even suggests that if there is “involuntary unemployment” then the reason for it lies not with the system itself but with the central bank whose monetary policy happens to be out of sync with the needs of the situation. The culpability for involuntary unemployment is thus neatly shifted from the system itself whose functioning is flawed, to the shoulders of the central bank.

The absurdity of such inverted thinking becomes particularly clear in times like the present, when in the United States (US), for instance, the long-term rate of interest has been pushed down close to zero, and yet there is no sign of a recovery from a state of substantial involuntary unemployment. In Europe, the central bank is even charging negative interest rates on loans to banks, provided these are given out as credit for certain purposes by the banks; and yet there is no sign of a recovery from the crisis that afflicts Europe. So inadequate has monetary policy become for stimulating the economy that some authors are now saying that pervasive negative interest rates even on deposits (and not just on central bank lending to banks) are the need of the hour, and, for achieving this, there must be an abolition of cash altogether, since the possibility of holding cash in lieu of bank deposits puts a floor to the interest rate at zero (Rogoff 2016).

This amounts to carrying the inversion of thought to an extreme degree: the flaws of the system are according to this argument blamed on the very existence of cash; and rather than having direct state intervention through fiscal means, including a fiscal deficit, as a way of achieving “social rationality,” what is advocated is “sound finance” combined with the very abolition of cash. The lengths to which reified thinking can be carried can be imagined from this.

What globalisation of finance has achieved, in short, is that the opposition of finance to fiscal deficits, or more generally to direct state intervention for increasing the level of activity, has become effective once again. This had been overcome, albeit temporarily, in the context of the changed correlation of class forces in the post-war period with the emergence of a militant (pre-Blairite) social democracy. The fact that finance is globalised while the state remains a nation state, ensures that the writ of finance runs; and this strips contemporary capitalism of any potential instrument for achieving even a semblance of social rationality.

There are only two possible ways that, even potentially, a semblance of social rationality can be achieved in contemporary capitalism. One is through a global state, or through a set of nation states globally coordinating their actions, providing a fiscal stimulus to the world economy by overcoming the opposition of globalised finance. The other is through individual states providing such a fiscal stimulus within their own particular economies by delinking themselves from the vortex of financial flows and thus withdrawing from the entanglements that contemporary globalisation entails. In either case, however, the opposition of globalised finance has to be overcome, and this requires a broad class alliance of working people which has to be organised in a manner appropriate to each case.

Whether such a class alliance can achieve a semblance of social rationality within the confines of capitalism itself, that is, whether capitalism will adapt itself to the new situation by making appropriate concessions, as it had done over large stretches of the capitalist world in the post-war years, or whether it will transcend capitalism in the process of introducing a semblance of social rationality, is a matter for the future. But the point is that until such an effort is made, world aggregate demand will remain constricted, and the world economic crisis will persist, apart from possible occasional “bubbles” that may cause temporary revivals, to be followed by collapses into crisis once more.

Legitimacy Crisis

Donald Trump’s economic strategy has to be understood in this context where he remains as tied to fiscal conservatism as other governments in advanced capitalist countries. Committed to increasing employment in the US, but unwilling to do so by expanding government expenditure, he is taking recourse to protectionism, which, in a situation where world aggregate demand is not increasing, amounts to a “beggar-my-neighbour” policy, that is, a policy of exporting unemployment to other countries.

True, Trump has said that he is not averse to increasing the fiscal deficit; but he is willing to do so only as a means of effecting a tax cut on the corporate sector (from 35% to 15%). This amounts to increasing the fiscal deficit for the sake of putting more purchasing power in the hands of capitalists. But putting more purchasing power in the hands of capitalists hardly increases aggregate demand: their marginal propensity to consume out of income is small, and they do not invest more, even if they have larger post-tax profits, as long as the market is not expanding. Hence, the Trump strategy really amounts not to an increase in aggregate demand in the US, but to a beggar-my-neighbour strategy imposed upon the rest of the world.

This strategy presupposes that the rest of the world would simply sit tight and tolerate an import of unemployment from the US: its success, in other words, depends upon the US action not facing any retaliation, that is, upon the US being able to impose “one-way free trade” upon the rest of the world, as Britain had done in the colonial period. But if other countries do retaliate, then competitive “beggar-my-neighbour” policies would ensue, which would increase uncertainties associated with investment, and hence aggravate the crisis.

But if the US individually or several (or all) countries on their own increased the fiscal deficit to expand government expenditure, and imposed protection only to the extent of preventing a leakage outwards of the additional demand so generated within their economies, without actually curtailing their imports in absolute terms, namely, without exporting any unemployment to other countries, then all countries would be Pareto-wise better off. No one country’s employment increase in such a case would be at the expense of some other country.

What comes in the way of such a move which would improve the employment situations in all countries without their adversely affecting one another, is the opposition of finance to fiscal deficits and to taxes on capitalists (taxes on workers would not raise aggregate demand as they already have a high propensity to consume). Unless finance capital’s hostility to fiscal deficits is overcome, which in turn requires that unless the hegemony of finance capital on the world economy is overcome, the world would remain mired in crisis.

Either way, therefore, world capitalism will be facing a legitimacy crisis in the coming days: on the one hand, if it remains committed to the “humbug of finance” then its legitimacy is threatened because of the persistence of the economic crisis, and with it of high unemployment; on the other hand, if it “permits” direct state intervention through fiscal means for overcoming the crisis, then its legitimacy is threatened because the flawed nature of the system gets exposed, thereby, opening the prospects of growing state intervention.