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Monday, Jan. 23, 2012

Europe's potion is now its poison with China inheriting the benefits


Today's lecture is on the sorry state of that dismal science called economics.

Hands up, economists who foresaw the Lehman collapse in the United States. OK, I see a few hands out there.

Now hands up, those who also foresaw the eurozone crisis? Not so many, it seems.

Hands up, those who realized from the start that combining nations with very different cultures into a eurozone economy was bound to fail? Almost none.

Finally, hands up, those who realized that the fashionable call for austerity policies would drive the European Union economies even further into disaster? I see a few — Paul Krugman who writes for the New York Times; Joseph Stiglitz, a Nobel Prize winner; one, possibly, two writers for Britain's Financial Times, which, with its ideological supply-sider bias, has often got it wrong in the past, over Japan especially.

The politicians, of course, have an even worse record. What do those of the Greek, Italian, Portuguese and Spanish variety have to say for themselves now that it is clear they were living in fantasy land?

"PIGS" was their well-deserved acronym, and one cartoon showed Madame Merkel of Germany trying to drive this sad collection of four-footed animals to fiscal salvation. In fact, she too got it wrong, and almost certainly is driving them to the abattoir with her Teutonic calls for fiscal rectitude and her refusals to allow the European Central Bank to come to a full-scale rescue.

As in Japan, few of the European policymakers seem to realize that while austerity policies may cut government spending, they cut tax revenues even more, leading to a net increase, not decrease, in official debt. As the crude saying puts it, they cannot walk and chew gum at the same time. They cannot get their minds around the need for two different policies simultaneously: Cut spending in nonproductive areas and expand spending in areas with strong stimulus effects.

How can so many of the best of our brightest get it so wrong? With the Europeans, there is no need even to ask. For years, their idea of a policy initiative was a good meal at a five-star restaurant. Their EU delegates who could find their way perfectly around the menus of the top Brussels restaurants could not even read national accounts well enough to discover that, for years, Greece was hiding 9 percent fiscal deficits. None seem to realize what the U.S. finally realizes: In a financial crisis, the loss of confidence is contagious and you must move quickly and strongly to expand spending. Debt problems can look after themselves later, when tax revenues begin to improve.

International economists are no better. My introduction to trade economics years back was the Heckscher-Ohlin theory of the 1930s that "proved" the virtues of free trade. The only problem was that it was based on the outdated principle of fixed or even diminishing returns to scale.

In today's world, almost every industry shows increasing returns — the more you produce the cheaper is the cost of each item. This means that under free trade, determined manufacturers can easily dominate production of almost any item if they seek ruthlessly to protect domestic markets and expand exports.

The free traders then say not to worry, that freely fluctuating exchange rates will keep things on track. But they do not move freely; adjustments are very jerky and harmful. And for very understandable reasons the currencies of developing nations will tend chronically to be undervalued anyway, giving them an even larger trade advantage since they usually also have lower labor costs.

Even here we were told not to worry, thanks to the racist doctrine that said the developed economies of the West would always be able to keep ahead thanks to their superior skills and work ethic. In that case go tell your average British worker that he need not fear the 3-to-1 wage and exchange rate advantage enjoyed by his Chinese counterparts since his bosses are three times smarter and he himself works three times harder. And don't forget also to tell him it is pure bad luck that his factory is being closed down and exported to China.

Free trade economics are a relic of the days when imperialist powers could use them successfully to prevent the industrialization of weak nations. Now ironically they are being used by the former weak nations to de-industrialize the former imperialist nations.

The only way to prevent this reverse de-industrialization from getting out of hand is either a large upward readjustment of exchange rates in the now unduly favored developing nations, or else heavy tariffs on imports from those nations, China especially.

And don't bore me with outdated anti-protectionist shibboleths. They, too, were inherited from the '30s.

By the way, if you want China to lend you the money to save your economy from the mess created by your economic commentators, let's put an end to the 1989 Tiananmen Square myths created by your political commentators and still being used to justify a Western anti-China embargo. Beggars usually do not usually insult and accuse would-be providers for crimes they did not commit.

(For the facts on past economic mistakes I recommend Krugman and Stiglitz, available on the Internet. For the Tiananmen facts simply go to the reports by the U.S. Beijing Embassy at the time, also available on the Internet.)

Gregory Clark, a former diplomat and economics student, is a longtime resident of Japan. For a Japanese translation of this article, go to www.gregoryclark.net.


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