PROTECTIONISM THE REAL THREAT

Protectionism - the real threat to growth, stability

At Nobelist Robert Mundell's recent Santa Columba Conference, the assembled group of specialists in international finance agreed on two points: 1) the global economy is growing faster than at any time in history, and 2) the number one risk to sustained global growth is rising protectionism in the United States.

This week in Washington, short-term politics won over long-term economics and basic humanity when the Senate Banking Committee voted in favor of a protectionist bill, joining a long list of bills aimed at China.

There is a race to the bottom among American politicians to determine who will get the honor of leading the lynch mob that blames China for every real or imagined economic ill. These political leaders are competing for short-term political gain at the risk of the global growth that is lifting billions of people out of poverty around the world. Worse still, they know exactly what they are doing.

On Wednesday of this week, 1,028 economists signed a petition to members of Congress, advising them of the immense benefits of free and open trade in goods, services, and capital, and warning them of the grave risk to growth and stability, both in and outside the US, from escalating protectionist measures that could lead to a global trade war.

As one of the signers of the petition, I spoke on the issue at a press conference on Capitol Hill organized by the Club for Growth, who ran the signed petition as a full-page display in the Wall Street Journal. Let's hope we had some effect on the policy makers.

Not coincidentally, 77 years ago, in May, 1930, 1,028 economists signed a similar petition, which ran as a full page in the New York Times. They were trying to convince Congress not to pass the Smoot-Hawley tariff legislation. They failed. I am convinced the tariffs then were a major contributor to the length and severity of the Great Depression that followed.

Today's global economy is in great shape. Global economic growth in 2006 was an incredible 5.4 percent, compared with 2.9 percent during 1950-73, when Europe and Japan were rebuilding their economies after the war, and 1.3 percent during the 1870-1913 industrial revolution. The IMF predicts 5 percent growth for both 2007 and 2008, which would mark the sixth straight year of growth in excess of 4 percent. Developing Asia - the epicenter of the world's economic growth explosion - will grow at nearly twice that rate, led by the spectacular growth of China.

The US economy is in good shape too, with growth in excess of 3 percent, contained inflation, profit growth of over 14 percent in the most recent quarter, and long-term interest rates below 5 percent.

If things are so good, then why are voters demanding protectionism?

I am convinced that today's chorus of protectionist actions represents more than the profit-seeking actions of a few special interest groups. Today, when a political leader announces a new protectionist measure, crowds cheer. I believe that rising protectionism, nationalism, and social instability are rooted in the turbulence caused by rapid economic change.

Rapid economic change raises average incomes but it creates new industries and destroys others, creating uncertainty in the lives of many people. Those, whose fortunes have been temporarily or permanently reduced, as well as those who are simply afraid of change, appeal to political leaders for relief; political leaders who promise to stop or reverse change will gain power over leaders who counsel openness.

Left unchecked, this process can lead to global trade war as country after country erects non-market barriers to the smooth flow of trade. Ultimately, these mounting frictions can produce system failure, akin to the blackouts caused by failures of an electricity network, in which the global economy stops growing, as it did in the 1970's.

Rampant protectionism could also breed social and political instability and, ultimately, bring nations into conflict. Political instability would put all the gains of the past quarter century at risk. The unintended consequences of protectionism would be harmful for people living in developed countries; they would be a tragedy for the world's three billion poor people.

We can choose a better course. Although we cannot entirely eliminate calls for protectionism, there are things we can do to retard its growth and mitigate its harmful effects. Here are a few ideas:

Policies to reduce frictions include training, education and relocation assistance for people experiencing change due to rapid global growth.

An education system that gives people the tools to adapt to change by emphasizing problem solving over rote learning will reduce turbulence.

Labor market policies that make it easy for companies and workers to change the nature of the work they do will reduce turbulence.

Policies that increase people's overall sense of security, such as reducing corruption, predictable rule of law, and a healthy environment with clean air and water, will reduce friction and turbulence.

A stable monetary environment with a predictable price level and a moderate, predictable tax system will reduce turbulence. I strongly urge China's leaders to resist pressure from the American government to revalue the RMB. A stable RMB will keep China's prices stable, deter speculation, promote increased FDI and sustainable growth.

The reason we care about protectionism is its impact on the lives of families trying to feed, educate, and care for their children to give them a better future. Protectionism attempts to stop change. But change is inevitable. It is a better use of resources to prepare people for change by giving them a stable society with a growing economy and by forward-looking education that gives people the skills and flexibility they will need for the jobs of tomorrow's global economy.