The Bear’s Lair: Nationalist and globalist threats to prosperity

It appears that the U.S. electorate in November will be faced with a Hobson’s Choice between two alternatives: a protectionist nationalist who will raise trade barriers and make the nation poorer versus a regulating environmentalist Keynesian who will equally impoverish the country and indeed the world in general. All over the world, political choices are being narrowed down to the same two unattractive alternatives. If the world of 2030 isn’t to be a deeply impoverished one, we need to show there is a third way, that avoids the deep economic errors of both fashionable dogmas.

In the 1990s, it was believed that a “Washington Consensus” of global free-market capitalism had emerged, that would propel the world to greater prosperity, with rich countries growing rapidly, and sharing their wealth with poor countries through the miracle of global sourcing, which benefited everybody.

In practice, this free market Nirvana never actually arrived. First, the increasing efficiency of modern communication created a massive arbitrage force between rich Western countries and the rest of the world, tending to equalize their living standards.

Although David Ricardo’s doctrine of Comparative Advantage states that both sides gain when production is shifted from a rich country to a poor one through the latter’s comparative advantage, it makes no statement about the outcome for the rich country when the frictional costs of international trade are suddenly lowered, so that all sorts of new comparative advantages are created.

It also (and for this Ricardo can be criticized) makes no statement about the possibility of the poor country using its new participation in the global supply chain to create new comparative advantages, as Indian software engineers gain new skills and Chinese factories mechanize and automate.

Ricardo also makes no claim about the outcome if poor country workers migrate to rich countries and take the jobs, not only of workers engaging in international trade, but of low skill domestic workers engaged in personal service jobs. Importing a new workforce to reduce domestic labor costs is the economics, not of Ricardo, but of the seventeenth century Virginia planters who imported first convicts and then slaves to provide them with labor at wage levels below those of free men in the scarce-labor high-wage colonial economy.

Thus even the genuinely free market elements of the “Washington Consensus” did not work too well for the Western workforce in the rapidly globalizing world.

There were two elements of the predominant globalist economics, as preached by the IMF in the last few years, that have made it thoroughly pernicious. One is funny money, the attempt to stimulate the economy by keeping interest rates artificially low and persuading central banks to buy almost infinite quantities of government bonds. The other is complete insouciance about budget deficits, together with a belief that there is no problem that cannot be cured by yet another wasteful burst of government spending.

This has resulted in most countries incurring mountains of debt that exceed even the excesses of 2007-08. The “deleveraging” that was much advertised in 2009 has not occurred; instead any debt that has been paid down in the private sector has been assumed by governments, who have piled up huge additional obligations of their own. Japan is the worst example of this, and seems inevitably headed for national bankruptcy, but Britain, the United States and most of the EU (not Germany) have headed in the same direction.

The other effect of “funny money,” not yet admitted by its perpetrators, has been to kill productivity growth in all major economies where the policy has been followed. U.S. productivity declined at a 1% rate in the first quarter of 2016, to much head scratching by Keynesians, but productivity performance in the Eurozone and Britain has also been far below par, while in Japan it has been truly horrendous.

The Keynesian-globalist combination has thus been increasingly unpleasant for those living in rich countries in what was supposed to be a rapidly growing global economy. For those in emerging markets, it has so far been fairly pleasant, partly because the worst elements in the mix have not been copied in the more successful emerging markets. However, the build-up in emerging market debt and the likelihood of a major world downturn in the near future suggest that even the beneficiaries of globalization will become at best conflicted about its benefits.

In several countries, we have now been presented with an alternative model, that of protectionist nationalism – one could call it “Trumpism” except that it has been tried already in several countries, such as Hungary and Poland, and is notably on the menu in others, such as France, Austria and now probably the Philippines.

Trumpism solves some of the problems of the Washington Consensus but not others. It is properly restrictive about immigration, thus at least slowing the erosion of rich-country living standards by the “Virginia planters” of the elite. Unfortunately, it combines this with a protectionism that would lower everyone’s living standards. China, India and other emerging markets have now used their Ricardian comparative advantages to become far more competitive than they were in 1996; blocking imports from those countries merely raises costs and lowers the living standards of all.

Trumpism is satisfactorily de-regulatory. Donald Trump himself has stated that global warming is a Chinese plot, and he has sufficient experience with foolish regulations to know just how damaging they can be. In this area at least he is a great improvement on the fashionable consensus, as are his counterparts in Hungary, Poland and elsewhere.

Trumpism also believes in higher minimum wages, a market distortion that won’t work. We cannot return to the secure factory jobs of the 1970s; we have too much automation. If Donald Trump or Hillary Clinton impose much higher minimum wages on McDonalds, McDonalds today can simply automate much of its operation, eliminating jobs altogether rather than being forced to pay too much for labor. No amount of protectionism or labor market regulation can force up the living standards of low-skill Western workers above their market value; they will simply create stagnant pools of the unemployable while raising costs for everyone else.

Trumpism does not address the two most damaging elements in the Keynesian consensus: its insane desire for ultra-low interest rates and its encouragement of budget deficits and government waste. Trump wants a massive infrastructure program (starting with the Wall) and has proclaimed himself a “low interest rate guy” (not surprising in a man who has made his fortune in over-leveraged real estate). He said that while he would expect to replace Janet Yellen as Fed Chairman it would merely be for partisan political reasons, to install a Republican.

Since as Ben Bernanke proved, there are plenty of nominal Republicans who are in practice devotees of Keynesian economics and monetary profligacy, this is no assurance of even a marginal improvement in monetary policy. It is incidentally a shocking commentary on the disgraceful performance of the moderators of no fewer than 12 Republican debates that Trump’s disappointing views on monetary policy were not brought out in any way well before he won the GOP nomination.

Without addressing the problems of interest rates and state spending, the new nationalist populism merely imposes additional barriers to the market’s free operation, preventing productivity from resuming its previous robust growth. It solves only a few problems of the Keynesian “Washington Consensus” and its failure could bring either a return to the consensus or the invention by the left of some even worse policy mix.

The correct policy approach is not hard to discern, nor is it different to that which has proved successful over the last three centuries. It involves relatively high interest rates, ideally anchored not by a central bank, which can be suborned by governments or, worse, by academics with daft theories. It involves small government, tight control of spending and budget surpluses – the German approach, ideally with a smaller state sector. It involves tight limits on immigration, with a predominance of skilled immigrants and an overall level around half that of the United States in recent years. It also involves massive deregulation, removing the enormous burdens progressively imposed on business over the last 40 years.

The correct policy mix involves free trade, but on a global basis, though treaties that do not in the name of “free trade” add all kinds of excessive rent seeking protections of intellectual property. Modest tariffs should not be completely anathema – they are taxes on consumption, and can be more efficient forms of government finance than high income taxes. The important function of a global free-trade regime is to avoid non-tariff barriers, which do not help to finance government and are economically equivalent to inordinately high tariffs.

As usual, the Republican primary system has thrown up the wrong answer, as always since 1980. However, if new errors can replace some old ones, rather than merely adding to them, some good may come of it. Conversely, if the Ossa of nationalist, protectionist error is piled on the Pelion of Keynesian globalist error, the world economy will stagger under very heavy burdens indeed.

(The Bear’s Lair is a weekly column that is intended to appear each Monday, an appropriately gloomy day of the week. Its rationale is that the proportion of “sell” recommendations put out by Wall Street houses remains far below that of “buy” recommendations. Accordingly, investors have an excess of positive information and very little negative information. The column thus takes the ursine view of life and the market, in the hope that it may be usefully different from what investors see elsewhere.)