Wednesday, October 15, 2008
Yesterday the Guardian published an opinion piece by Kevin Gallagher (Washington Consensus Dead?) on Nobel Laureate Paul Krugman's work on strategic trade policy, pointing out that his Nobel Prize is the nail in the coffin of the free trade "Washington consensus." Krugman explains why it is rational for governments to engage in strategic use of tariffs and subsidies in order to create a niche industry. The same sort of strategic trade policy makes it rational for governments to engage in strategic use of tariffs and subsidies to support ecological sustainability and social well-being. Perhaps the pendulum will swing against the free traders enough so that we can protect the global environment through trade and other economic sanctions against nations unwilling to act in a socially and environmentally responsible manner.
Last Friday the New York Times quoted the World Bank as saying "There's no question the Washington consensus is dead," indeed it "died at the time of the $700bn bail-out." If the bail-out is death, then awarding Paul Krugman the Nobel prize for economics is the nail in the coffin.
Paul Krugman did not win the Nobel for his popular critiques of Bush-era economic policy in his New York Times column, though the column no doubt helped raise his profile outside the economics profession. The Nobel committee cited Krugman's theoretical contributions to the economics of international trade, the policy implications of which fly in the face of the Washington consensus ( where the mantra is to free up trade every chance you get).
Among Krugman's achievements in the field of international trade is "strategic trade policy". In this work Krugman (and others) showed that tariffs and subsidies to domestic industries can divert profits away from highly concentrated foreign firms and increase a nation's income. Though Krugman himself shies away from prescribing such policy, the textbook example of strategic trade theory is the choice by the Brazilian government to subsidise and develop the aircraft company Embraer. The free-trade theories espoused by the Washington consensus would warn Brazil of the high cost of subsidisation. To free traders, Brazil should focus on its advantage in agricultural products and forget about climbing the manufacturing ladder. Strategic trade theory helps explain why Brazil was willing to gamble in the short term to become one of the finest aircraft manufactures over the long term. They squeezed foreign firms out of the market and carved out a global niche for themselves.
In another classic book, Development, Geography, and Economic Theory, Krugman argued that the government should also play a role in connecting beneficiaries of strategic trade policy to the overall economy. Evoking the work of economists such as Albert O Hirschman and Paul Rosenstein Rodan, Krugman argued that developing countries often needed a "big push" of coordinated government investments to help strategic industries get off the ground and to link the growth of such industry to the economy as a whole.
Problem is, today's trading system is out of whack with these frontier issues in economic thought. In a study published by Boston University's Pardee Centre for the Study of the Longer-Range Future, trade lawyer Rachel Denae Thrasher and I examined the extent to which the World Trade Organisation (WTO) agreements, European Union trade agreements, and United States trade agreements bit into a nation's ability to deploy strategic trade and other industrial policies to benefit from the globalisation process.
We find that in general the world's trading system makes it much more difficult for nations to craft strategic trade and industrial policies for growth and development. Indeed, enshrined in virtually all trade agreements is the "national treatment" idea that says a nation may not treat its domestic industries any differently than foreign ones. That may make sense when rich nations compete against each other, but in a world where 57.6% of the population lives on less than $2.50 per day, one size can't fit all. This restriction is accentuated in provisions for foreign investment, intellectual property, and subsidies.
Interestingly however, we find that there is more "policy space" for innovative growth strategies under the WTO than under most regional trade agreements – especially those pushed by the US. In fact, we find that US-style trade agreements are the most severe in constraining the ability of developing countries to deploy such policy. EU agreements, interestingly, tend to have the same policy space as the WTO.
It doesn't make sense that the World Bank and (implicitly) the Nobel committee are declaring the death of the Washington consensus when the US is choking the ability of nations to use policies that are gaining increasing legitimacy in theory and practice. Change is in the air. As we know in the aftermath of the financial crisis, the US has justified – like never before – a strong role for government in economic affairs. And, of the two presidential candidates, Obama has expressed concern over the direction of US trade policy and has pledged to rethink it. Perhaps these events will make strategic trade and industrial policy rise again.