Monday, March 19, 2012

Two Trade Policy Disasters

Recently I have been reading instead of blogging. One outstanding book I had on my reading list is Douglas A. Irwin’s "Trade Policy Disaster" (MIT Press, 2011) subtitled “Lessons from the 1930s.”

The author, a professor of economics at Dartmouth College is, according to Jadish Baghwati – an expert – “the most influential economic historian of trade of his generation. Indeed, he ranks with the best scholars of international trade today. This splendid account of the ‘trade wreck” of the 1930s shows why. It is masterly.” I agree.

“Irwin argues that the extreme protectionism of the 1930s emerged as a consequence of policymakers’ reluctance to abandon the gold standard and allow their currencies to depreciate. By ruling out exchange rate changes as an adjustment mechanism, policymakers turned instead to higher tariffs and other means of restricting imports. He offers a clear and concise exposition of such topics as the effect of higher trade barriers on the implosion of world trade; the impact of the Smoot-Hawley tariff of 1930; the reasons some countries adopted draconian trade restrictions (including exchange controls and import quotas) but others did not; the effect of preferential trade arrangements and bilateral clearing agreements on the multilateral system of world trade; and lessons for avoiding future trade wars.” (from the front flap).

These lessons are especially useful in the Eurozone today since member countries are caught in the “Deutsch Mark – or ECB -- fetters” whereas in 1930 most developed countries were caught in the “Golden fetters” of the Gold Standard. The situation is basically the same. In denial of the dramatic negative effects of exchange rate disequilibria that, quite like the fixed parities with gold in the 1930s, destroy competitiveness and bring about recession and budget deficits, Eurozone members are more and more tempted by protectionist pseudo solutions, rather than recognizing that the traditional remedy of exchange depreciation is urgently required.

This makes all the more surprising a commentary on the back cover in which Barry Eichengreen, the author of a much critical book of the gold standard of the 1930s, claims that “ the Great Credit Crisis of 2008-2009 was the most serious financial crisis in nearly 80 years, but one respect in which we did better was in avoiding the disastrous trade policies of the 1930s.” Well that’s true of the US and the UK certainly but the Euro is precisely similar to the gold standard of the 1930s, even going farthest in its suppression of national currencies, and thus exchange rates, to forbid any use of the exchange rate mechanism.

Ann Krueger concurs: “There was much less resorting to protectionist measures in the Great Recession than there was in the Great Depression. Douglas Irwin carefully reviews the disastrous protectionist policies of the 1930s and shows that countries that persisted in fixed exchange rates heightened protection much more than those that abandoned a peg. He concludes that many more countries had flexible exchange rates.”  Quite true, but unfortunately for the Europeans the continent’s politicians, business elites, and economists (including Eichengreen among so many  other) went all in support for “definitively fixed” exchange rates in the guise of the euro. A dramatic mistake of historical dimension.

It follows that we are now heading for disastrous consequences of which the Greek  drama is the first example. The lessons of recent history indeed have not yet been learned on this side of the Atlantic.

One last tragic misunderstanding is that public opinion on both the left and the right of the political spectrum sees the euro system as an example of an “ultraliberal” policy and a dogmatic application of a free market system, while in fact it is a system that suppressed intra European exchange rate markets, and replaced them with a politically defined arbitrary price, the entry parity in the euro (remember the rule of one euro = 6,55957 French francs ?). This is a pure example of the “novlanguage” in “1984”: the contrary of the truth. And it leads to a compounding of errors: one market distortion, the suppression of national exchange rates and currency markets, leads in this case to other and even more damaging contemplated distortions: protectionism, supposed to compensate the boost of imports and shrinking of exports that the arbitrary and overvalued common exchange rate entailed.

Yes, there are lessons to be drawn from the disastrous mistakes of the 1930s. But let’s learn faster, please. 

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