A global economy divided against itself cannot stand

Twenty-five odd years ago when I was struggling as a U.S. trade negotiator to "open" Japan’s markets a friend and long time resident of Japan commented that the real "breakfast of champions is raw mercantilism."

I was reminded of that this morning while participating in a discussion on National Public Radio on the European financial crisis and the possibility that China will emerge not only as the savior of the Euro and the EU but also as the dominant global financial power. The discussion focused on the fact that the European Financial Stability Fund (EFSF) needs something north of $1 trillion and that representatives of the EU who are searching for investors in the fund made Beijing their first stop because with more than $3 trillion of reserves China could easily solve the European problem all by itself. The question being posed was whether China should and would invest and what it might demand as the price of investment.

Some argued that because the EU is China’s biggest export market, China has a major stake in Europe’s continued prosperity and should therefore contribute to a bailout of the European financial system. But it was emphasized that China would likely only do this in return for Europe meeting certain demands. For example, Europe does not recognize China yet as a market economy. This gives it great flexibility in regulating and even limiting imports from China. The EU also bars exports of certain military goods to China, and sometimes lectures China on human rights issues. The discussants argued that China would demand an end to all of these policies and practices as the price for contributing to the bailout. It was also suggested that China might make a contribution via the IMF and that if it did so it should only do so on condition of being granted the same status in the IMF as the United States. Obviously the drift of this conversation was in the direction of the emergence of China as the power calling the tune in and displacing the United States from leadership of the global economy.

At the same time, the role of Germany was also described as the key to the future of the Euro and the EU. Germany is not only Europe’s biggest economy, but it also operates its economy with a huge trade surplus and accumulates large financial reserves as a consequence. In all of the efforts to overcome the crisis in Europe to date, it is Germany that has been calling the tune.

What irony. For more than fifty years, the United States and the global institutions like the IMF, the World Bank, and the World Trade Organization (WTO) have been preaching a laissez-faire brand of free trade. They have argued that free trade is always and everywhere a win-win proposition and that even one-sided, unilateral free trade is preferable to any form of protectionism. They have further argued that mercantilists who protect their markets, manipulate their currencies, subsidize targeted strategic industries, and accumulate chronic trade surpluses as a matter of policy are only hurting their own consumers and their own economies. The premise behind this thinking is the Adam Smith principle that the sole object economic activity is consumption. Now, however, it turns out that the free trading, laissez-faire, consuming economies are turning to the more protectionist mercantilists like Germany and China to save them.

The truth is that the object of economic activity can also be wealth creation and the accumulation of power. By accumulating trade surpluses and large financial reserves the mercantilists also accumulate power, including the power to impose conditions that may make it harder for the consumption focused economies to consume.

The global economy cannot persist in a half-mercantilist and half-free trade structure. Regardless of who bails out whom, there will be a convergence of the two systems toward one of more managed and regulated globalization.