The new mercantilists

Mercantilism used to be the dominant economic theory of trade policy until the early 19th century. This was the belief that an economy that ran a trade surplus would be wealthier and stronger because of the inflow of bullion, or assets. There were 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.
This is why such arguments have been discredited for a while. 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. 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 had mostly small trade deficits till the late 1990s, and started having large trade surpluses only in the early part of the 2000s.
But since then both China and Germany have been focused on pushing out more and more net exports. This has required suppressing domestic wages and consumption. In China the consumption to gross domestic product (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 recognises the absence of full employment and seeks to use trade as a means of maximising 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 for your trade partners.
This argument too is essentially fallacious because it does not recognise that trade can affect the pattern of employment, but the aggregate level of employment is determined by macroeconomic policies. The possibility of employment in non-traded activities making up for employment losses through trade (which would have to be the results of active government intervention as well) is not considered.
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 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 (EU).
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, as has been evident as Germany and China continue to power on through the global crisis and its aftermath. In Germany, the ability to impose wage restraint throughout the period of economic boom and rising labour productivity was remarkable in its 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 EU. This 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 Germany 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.
So prices of many goods and services are significantly lower (sometimes by as much as one-third) in Germany compared to most other European economies. This means that the European Single Market has failed to equate prices of goods even though there are no trade barriers, and also failed to ensure wage equalisation even though labour is free to move.
But such mismatches cannot continue indefinitely. Already the deficit countries in Europe — not only those whose governments and 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. In fact, this process is already underway.
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.

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