For several centuries - between the
15th and the early 19th centuries - mercantilist theories dominated the
attitude to trade in Europe. This was the belief that an economy that
had positive net exports (through exports being greater than imports)
would be wealthier because it would lead to an inflow of bullion, or assets,
and thereby increase its economic strength. This approach led to economic
policies designed to increase exports and suppress imports, trade wars,
and even the colonial wars that were crucial to ensuring markets for the
various European powers.
There were of course many flaws of mercantilist theories, most notably
the confusion of bullion with real economic wealth, the lack of recognition
of the various benefits of greater trade independent of the trade balance,
and the failure to perceive that the purpose of increasing exports is
to be able to import more, and thus raise the level and variety of consumption
in the society.
For a relatively long time, mercantilist arguments have been discredited.
But recently, a new form of neo-mercantilism has emerged and has propelled
the economic models of the two economies that are increasingly seen as
the most successful and potentially powerful in the world: China and Germany.
Mercantilism - the obsession with net exports - is often seen as identical
with export-led growth, but in fact the two are not the same. It is possible
to have exports as the basic engine or driver of growth without necessarily
running a trade surplus. All that is required is that export demand becomes
a catalyst for growth in the rest of the system and generates additional
demand.
Indeed, some of the classic examples of recent export-led growth, such
as the East Asian “dragons” or the Southeast Asian economies, generally
ran trade deficits during their period of high export-led growth. Even
China's trade surpluses are of relatively recent vintage, since the country
had trade deficits during the period of rapid export growth from the early
1980s to the late 1990s, and only started having large trade surplus in
the early part of the 2000s.
However, for the last decade in particular, both China and Germany have
been increasingly reliant on a strategy of growth that requires pushing
out more and more net exports. This in turn has required suppressing domestic
wages and consumption. In China the consumption to GDP ratio fell from
46 per cent of GDP in 2000 to less than 36 per cent in 2007, while in
Germany it fell from 60 per cent to 56.5 per cent in the same period.
Why would such a strategy be attractive at all? After all, no one really
still believes that an inflow of bullion (or a net accumulation of financial
assets, which amounts to the same thing) is of great intrinsic value for
an economy. It could be argued that the current strategy is based on a
different notion of the gain; one which recognizes the absence of full
employment and seeks to use trade as a means of maximizing employment.
Thus net exports are valued because they involve more productive jobs
at home and less leakage of jobs through imports. To that extent, this
is also a form of beggar-thy-neighbour economic strategy, since it involves
creating or preserving jobs in your own country at the expense of jobs
in your trade partners.
This argument too is essentially fallacious, because it does not recognise
that while trade can affect the pattern of employment, the aggregate level
of employment is determined by macroeconomic policies. The possibility
of employment in non-tradable activities making up for employment losses
through trade (which would have to be the result of active government
intervention as well) is not considered.
Despite this, the urge to generate trade surpluses has become an important
plank of the overall economic strategy in both countries. It is possibly
even more marked in Germany than in China, which has seen some recent
moves to develop the home market.
Even more than export-led growth per se, such a strategy involves a fallacy
of composition, in that all countries cannot pursue it. Indeed, the dependence
of the surplus economies on the existence of other countries that are
simultaneously running deficits is only too obvious. In the recent past,
that has come from a combination of one large global player (the US economy,
which has served as the engine of growth for much of the rest of the world)
and a number of smaller economies running smaller deficits financed by
capital flows.
This gives rise to a classic dilemma of mercantilist strategy, which is
evident in an exaggerated form today for the neo-mercantilist economies:
they are forced to finance the deficits of those countries that would
buy their products, through capital flows that sustain the demand for
their own exports. Thus it is no accident that China and Germany are both
large investors in the US and purchasers of US Treasury Bills, or that
German banks are heavily implicated in lending to the now-fragile deficit
economies in the European Union.
Despite these contradictions and dilemmas, such a strategy can certainly
be successful for a while, and this can be true even over the economic
cycle. This is evident from Chart 1, which shows how both China and Germany
experienced very sharp declines in export growth in the wake of the recent
global crisis, but have since rebounded sharply.
(It should be noted that all charts refer to merchandise trade only.)
Interestingly, Chart 1 also shows how the United States
economy had been showing reasonably high export growth before the crisis
and how its export growth has also revived (largely related to dollar
devaluation) in the most recent period.
Chart 2 indicates how the trade surpluses of these two mercantilist economies
are related to the deficits run by the US. The US deficit is obviously
much larger than the combined surpluses of these two countries, but as
it has shrunk slightly in the wake of the crisis, so have their surpluses.
Nevertheless, both countries have maintained the tendency
to generating trade surpluses, alough there has been some shift within
China. In Germany, the ability to impose wage restraint throughout the
period of economic boom and rising labour productivity were remarkable
in their scope, and critical to the enhanced competitiveness of the economy.
During the crisis, employment levels fell relatively little, not only
because of the existence of automatic stabilisers that provided a countercyclical
cushion for the economy, but also the willingness of German workers in
export industries to accept effective wage cuts rather than lose employment.
In any case in Germany, a significant part of the export surplus is generated
from trade with other partners in the Euopean Union (EU). Intra-EU trade
accounts for around two-thirds of total EU trade, and an equivalent part
of German trade as well. Chart 3 shows how movements in Germany's trade
surpluse have been closely mirrored by movements in the aggregate deficit
of all other EU countries.
It is this misalignment within Europe that is at the
heart of the economic problems faced by many deficit countries in the
region today. There is a basic difference between price levels in Gemany
and most other EU members, resulting from the fact that Germany has been
able to keep wages nearly stagnant even with rapid labour productivity
increases, while other countries are not able to let the gap between wages
and productivity widen to that extent. This means that prices of many
goods and servies are significantly lower (sometimes by as much as one-third)
in Germany compared to most other European economies.
Remarkably, therefore, there are real exchange rate mismatches within
a common currency area. Obviously this reflects another significant failure,
that of the European Single Market to ensure price arbitrage of traded
goods, or wage equalisation through the movement of labour.
What is more significant for present purposes is that such mismatches
cannot continue indefinitely. Already the deficit countries in Europe
- not only those whose goverments' bond markets are in difficulties but
others as well - are being forced to cut down on imports through very
severe austerity measures that are reducing both output and employment.
Ironically, such moves are being strongly pushed by the German government
inside the EU, even though this is likely to rebound adversely on the
German capacity to generate export surpluses.
In the US, the external adjustment will also clearly occur, whether through
exchange rate movements or increased protectionism, or in any other manner.
Chart 4 suggests that this process is already underway: although import
levels of both the US and non-Germany EU have recovered slightly from
the trough of early 2009, they are still far below the earlier peaks and
also appear to be levelling off despite the recent output recovery.
So, while the neo-mercantilist strategy can be apparently successful for a while, it is likely to come up against both internal and external constraints. Internally, the potential for suppression of wage incomes and domestic consumption will meet with political resistance. Externally, deficit countries will either choose or be forced to reduce their deficits through various means. In either case, the pressures to find more sustainable sources of economic growth, particularly through domestic demand and wage-led alternatives, are likely to increase.