- The Washington Times - Tuesday, June 9, 2009


The global economic crisis appears to be stabilizing, with recovery clearly under way in China and likely to commence in the U.S. over the next few months. The G-20 Summit in London in early April accomplished a good deal, especially in expanding the ability of the International Monetary Fund to counter the turndown in poorer countries and recommitting the major economic powers to refrain from protectionism.

But this is no time for complacency on the international front. There remains a persistent threat of pressure in major countries to adopt new trade barriers and other mercantilist measures that could strangle the trading system and stifle renewed growth. The Obama administration has declared its intention to thwart these dangers. But its goals must now be converted into day-to-day vigilance and action, including a willingness to “name and shame” violators of trade and currency norms both at home and abroad.

The “new mercantilism” takes many forms. Despite their pledge at the first G-20 summit last fall, most of its members have erected new distortions to international trade. A number of major emerging-market economies (including Brazil, India and Russia) have raised tariffs. Argentina and Indonesia have imposed new licensing requirements on imports. The European Union and China have reintroduced export subsidies. The U.S. is restricting government procurement of foreign products under the new fiscal stimulus program and has imposed restrictions on Mexican trucks that have provoked retaliation on American exports to Mexico.

Most countries taking these steps, including the U.S., defend them as consistent with the rules of the World Trade Organization and other international trade agreements. But such increases in “legal protectionism” have the same negative impact on the prospects for global recovery as any other interference with international trade.

Since the London summit in early April, the advent of new protectionist measures appears to have declined, but we are not yet out of the shadow of this crisis or the possibility of new protective actions. Sector-specific rescue programs, especially for automobiles both here and in several other countries, generate particularly strong pressures to erect such barriers.

There is an even bigger risk from the new mercantilism: an outbreak of competitive currency depreciation as countries push their exchange rates downward to try to export their way out of the crisis. Ireland has accused the U.K. of hurting Irish manufacturing by talking down the value of the pound sterling. Switzerland has overtly weakened its franc to support exports. Emerging-market countries such as South Korea and India, whose currencies have declined sharply, may resist their rebound. China’s exchange rate has climbed substantially but is still considerably undervalued, and its authorities have blocked any further rise against the dollar for almost a year.

We fear that many emerging markets, and even some richer countries, may also draw an ominous lesson from the crisis for their longer-run policies: They need to build even larger war chests of foreign exchange to defend themselves against similar or even greater shocks in coming years. Russia held the world’s third-largest reserves, about $600 billion, not long ago but burned through half of them in a few months. India and South Korea each accumulated more than $250 billion but lost tens of billions just as quickly. These countries could target future reserve levels of $1 trillion or even more.

The lure of this new mercantilism will depend to an important extent on the success of China. If it manages to escape with a much smaller proportionate drop in growth than most countries and indeed leads the global recovery, as now look likely, the “China model” with its massive $2 trillion of reserves will appear very attractive. Many more countries could try to keep their exchange rates highly competitive, run large surpluses and acquire foreign assets to self-insure against a rainy day.

But will the U.S. or anyone else be willing to run the counterpart trade deficits? Japan was able to keep its economy afloat during its “lost decade” of the 1990s by exporting to the U.S. and elsewhere. The Asians were able to recover from their financial crisis a decade ago by selling abroad.

But the huge inflows of foreign capital required to finance America’s large trade deficits promoted loose monetary conditions and low interest rates, encouraging the financial overleveraging and underpricing of risk that brought on the current crisis. Further sizable increases in the net foreign debt of the United States, already approaching $5 trillion, would continually jeopardize its economy and further erode its international influence.

The U.S. trade deficit has now come down by several hundred billion dollars, and the Obama administration has hinted, especially with its references to China’s undervalued currency, that it will resist letting it go back up. “Euroland” is the only other region large enough to run the requisite trade deficits, and its history suggests there is no chance it would accept doing so.

Hence the new mercantilism could produce serious clashes among nations. A few smaller countries might be able to get away with such a strategy, but the world as a whole cannot because one country’s export is another country’s import. We are already seeing that efforts in this direction trigger emulation and retaliation. The result is that growth would be further impeded, perhaps sharply, as trade declines even faster and as countries try unsuccessfully to exploit foreign markets rather than expand domestic demand. If enough large players join this competition, as is all too possible, the world economy could spiral downward as in the 1930s.

The participants in the G-20 London summit pledged to “refrain from competitive devaluation of our currencies” and they should further push that initiative at their next meeting in New York in September. In the absence of such multilateral steps, individual countries will pursue the new mercantilism and seek to defend themselves against it unilaterally. The Obama administration and its partners abroad have taken the first steps to integrate these global economic issues into their recovery strategies and place them high on the overall foreign policy agenda. But this will be a long process, and the administration and the other key countries must maintain their vigilance even if the world economy begins to stabilize over the coming months.

• C. Fred Bergsten and Arvind Subramanian are director and senior fellow, respectively, at the Peterson Institute for International Economics.

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