April 4th 2009

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Articles from this issue:

EDITORIAL: A way out of the economic tsunami?

CANBERRA OBSERVED: Senator Steve Fielding's political challenge

COMMONWEALTH GOVERNMENT: Rudd Government's radical agenda by stealth

NATIONAL AFFAIRS: The Liberal Party faces moment of truth

QUEENSLAND STATE ELECTION I: Labor's Anna Bligh returns to power

QUEENSLAND STATE ELECTION II: Leading abortion campaigner defeated

ECONOMIC AFFAIRS: Can free trade theory survive the global slump?

ENVIRONMENT: Global cooling is here: Don Easterbrook

BIOETHICS: Plant liberation: Europe's next cause célèbre?

UNITED NATIONS: Voices for the unborn heard at UN session

OPINION: Granting scientists power to take innocent life

F.D. Roosevelt and Obama's strategies (letter)

Agriculture the best-performing sector (letter)

Increasing populations (letter)

CINEMA: Easy Virtue - Dark side of 'deliciously funny comedy'

BOOKS: SMACK EXPRESS: How Organised Crime Got Hooked on Drugs, by Clive Small and Tom Gilling

BOOKS: JOURNEY TO ETERNITY: Victim of Apartheid: a novel, by Eric Carman

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Can free trade theory survive the global slump?

by Colin Teese

News Weekly, April 4, 2009
Free-traders don't like the idea that the response to shrinking demand puts most emphasis on rebuilding domestic real economies and employment, writes Colin Teese.

According to former federal Labor leader Mark Latham, "A small, open economy can only grow as fast as its trading partners." If Latham is right, Australia is in trouble - along with free-trade Singapore.

Unlike the small island city-state of Singapore, which had no choice, Australia chose to tie itself to the international trading system. So, whenever we sit down to determine where the financial crisis may lead Australia, a good starting point is our link with international trade.

Readers will have noticed that, in the context of our present crisis, advocates of financial deregulation have largely gone to ground. Meanwhile, at least here in Australia, advocates of free trade remain as unreconstructed as ever.

There has, however, been a subtle shift in positioning. A couple of years ago there was, at best, only token support for the idea of bilateral "free trade" deals outside the framework of the World Trade Organisation (except, that is, from consultants acting as paid advisors to the Australian Government's efforts to conclude so-called "free trade" agreements).

Shrinking domestic demand

As to the present crisis, free-traders don't like the idea that the response to shrinking domestic demand puts most emphasis on rebuilding domestic real economies and employment. Presumably, their preference is to use domestically-funded rescue packages to create jobs offshore - they hope!

Fortunately, Western governments now understand, as never before, that sacrificing domestic economic growth to benefit international trade - precisely as promoted by the advocates of free trade - was always an ill-advised policy, and has actually contributed to both the extent and severity of the present crisis.

The free-trade philosophy, encouraged by zealots throughout most of the West, has also resulted in national economies dividing the world into saving/export economies and spending/import economies, and, in the process, has grossly distorted the operation of the world's trading system.

It was, and remains, an affront to common sense to assume that two such groups could co-exist harmoniously. Little more than a moment's reflection is needed to imagine why this arrangement was unsustainable beyond the short-term.

Now it is all out in the open. The long-term consequences of one side hoarding foreign currency, and the other side borrowing and spending what it has not earned, have been catastrophic.

As economies slow, consumers in the spending economies necessarily must tighten their belts. The first casualty is imports.

Furthermore, the governments of these economies must begin to create demand at home if those being thrown out of work are ever to be re-employed. Taken together, these policies quite obviously impact adversely on the exports of the savings economies, and consequentially on their own prosperity and on overall trade volumes.

Only the free-traders seem unable or unwilling to recognise that a collapse of this fatally flawed system was inevitable; the recent financial crisis and its aftermath have merely accelerated that process.

The collapse of the major financial institutions has also had a direct impact on trade flows. As banks lost confidence in each other's solvency, the capacity of exporters and importers to exchange letters of credit was seriously affected. Since these instruments are the lifeblood of trade flows, the inevitable consequence has been a further slowing down of trade volumes.

Quite possibly. the effect on genuine international trade is even worse than the figures suggest. In the last 20 or so years, inter-company movements of goods and services have contributed much to the overall volume of international trade. This form of trade, we may assume, will be the least affected by the present crisis. Accordingly, the raw figures almost certainly understate the impact on genuine trade flows.

Free-traders don't want to hear any of this; they have their own mantra. It goes like this. The Great Depression of 80 years ago was caused by protectionism. It is no answer now, so they insist, as it wasn't then, to close markets. In effect, they are trying to tell governments that maintaining international trade flows is more important than protecting the domestic economy. Few can afford to listen.

The idea that protectionism caused the 1930s Depression is a complete fabrication. Borders were closed then for the same reason that they are being closed now. With slowing economies and unemployed workers, countries can neither justify nor pay for imports at the same level as before.

It is worthwhile having a look at the arguments of the free-traders. There is the "Latham" position, as quoted above. Others insist, in apparent contradiction, that free trade is better, even if others don't reciprocate. These are the so-called "practical" positions.

And there can be no refuge in theory. Pure theory tells us that free trade is universally beneficial only in conditions of perfect competition and full employment - neither of which has ever been simultaneously in place.

Free-traders ignore all of this. They insist that their system self-regulates. As one country's exports rise, its exchange rate rises correspondingly, making its exports more expensive. That's the automatic correction mechanism preventing any one exporter from attaining permanent dominance.

However, this mechanism does not work if an exporting country decides not to allow its exchange rate to rise as it should. This is precisely what China has done. Indeed, it has been the practice of every emerging economy since the end of World War II. Japan and China have been notable examples of this.

A Western trading world functioning in a system with no commitment to free trade was able to counter rogue exporters by imposing appropriate border protection measures against them. The free-trade commitment has made that impossible.

If the free-trade policies so widely accepted since the conclusion of negotiations to create the World Trade Organisation (WTO) in 1995 have told us anything, it is that a hands-off trade policy doesn't work.

The present crisis has at least brought all of this into sharper focus. Yet there is so far no sign that countries, acting independently or in groups, have any firm ideas about feasible future directions.

It is quite possible we will not see any decent program articulated. It may be that countries will implement ad hoc and piecemeal measures aimed at short-term fixes, and that these will form the basis of a new policy direction. That is what appears to have happened in response to the Great Depression.

Trying to do the same sort of thing this time will be more difficult. The extent of the financial crisis seems wider and deeper than 80 years ago, and governments of troubled economies back then had the luxury of leaving them to limp on for 10 years until the war rescued them. People aren't likely to be as tolerant again.

As World War II drew to a close, new economic institutions were created for the postwar non-communist world. The 1944 Bretton Woods Conference fashioned the International Monetary Fund (IMF), the General Agreement on Tariffs and Trade (GATT) and the World Bank.

These three institutions effectively came to control money flows, international trade and economic reconstruction and development.

In a much simpler world environment, the IMF and the GATT (forerunner to the WTO) can be said to have worked reasonably well. Since the recent crisis, however, informed opinion believes that these institutions are no longer relevant to the world's needs.

At this stage, what form of new organisations we need is not clear. But perhaps the one in most need of urgent overhaul is the World Trade Organisation. Above all else, doing so would allow us the chance to revisit the free trade issue in some realistic way.

Commentators like Mark Latham talk disparagingly about those who hold on to the "fossilised economic theories" of John Maynard Keynes (1883-1946). How about his own unswerving commitment to the even more ancient theories of Adam Smith (1723-1790)?

The idea, once popular, that trade could most help the poor in poor countries become richer, without making the poor in rich countries worse off, now seems less defensible. Recent events seem to suggest the opposite. At best, trade is a zero-sum game: one country's gain is another's loss.

Taken together, these facts alone ought to be enough to change the attitudes of governments, but there are also other considerations.

The idea that countries have natural advantages and that these should govern trade flows can no longer be seriously maintained. What natural advantages does Japan enjoy? Japan's export advantages have been self-created. So have those of most other countries.

In a strange way, if the world continues to take seriously the issue of carbon-emission reductions, sooner or later Australia is going to face a major trade dilemma.

The die is cast

Australia must find a way to safeguard its interests in the debate on carbon-dioxide emissions. As far as the debate itself is concerned, it seems that the die is cast. Along with the US, we will now become party to some kind of internationally agreed policy. The important remaining question is what we do, and how. To this writer's mind the "how" is much more important than the "what".

Overwhelmingly, the support is for some kind of market-based licence-trading for carbon dioxide emissions. For Australia this would be disastrous because we have a lot of so-called greenhouse gas-emitting industries.

A trading scheme would seriously hamper such industries' room to manoeuvre. Some kind of dedicated tax on emissions (which would also apply to imports) would suit us much better.

The proceeds from these collections could be used for the necessary research needed to reduce greenhouse gas emissions to whatever level we agreed internationally, but without working against the interest of our industries.

Only a tax approach can do that.

- Colin Teese is a former deputy secretary of the Department of Trade.

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