Bad enough when two elephants make love, far worse war…

Sunday, June 17, 2018

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All markets need to be embedded in an economic policy framework to manage the inevitable gyrations which are characteristic of markets.

This is necessary to prevent market failures of excess, or collapse driven by speculation, manipulation such as monopolies, overproduction, and underinvestment.

Every Government seeks to perform this function in a variety of ways ranging from State-controlled economy to free market laissez faire. The problem of the management of the global economy is that there is no global Government to stabilise the operations of the global market.

After the Great Depression and World War II, a troika of multilateral institutions was established: the International Monetary fund (IMF) to keep international payments flowing; the World Trade Organization (WTO) to prevent the collapse of international trade from protectionism; and the World Bank to entrench the market in developing countries and keep them open to foreign direct investment.

The rich countries have always controlled these institutions and imposed rules on other countries while exempting themselves. This is why since 1944 the IMF managing director has always been a European and the World Bank president an American. The US holds a veto in both institutions.

It was understood that the US would rule but consult with a small group of advanced capitalist countries — the Group of Seven (G-7) which consists of Canada, France, Germany, Italy, Japan, United Kingdom, and the United States, together representing half of the world's GDP.

The problems with this arrangement for international management are: First, it excludes communist countries, notably Russia and China. Second, US dominance has declined; therefore, the US is expected to consult the G-7, not dictate to them. This calls for skills in diplomacy on how to win friends, maintain allies, and influence enemies.

The dilemma facing the US is that its massive trade deficit with China is outside the ambit of the WTO and cannot be resolved in the G-7.

There are two options: negotiation or trade war. The US trade deficit is the result of the working of market forces, and China, being far more internationally competitive, is exporting much more to the US than it is importing. China's high and sustained rate of economic growth is export-led.

China and the US are not economic enemies, they are interdependent, but that interdependence is out of balance. US production is suffering and for the ultimate answer of becoming internationally competitive to be achieved it will take many years and much investment.

US President Donald Trump's strategy is that if the Chinese want the US market they must forget market forces and in the short-run take deliberate measures to reduce the trade deficit, buying more from the US.

This may not conform to the principles of free trade and the conventional rules to which all other countries are expected to conform. Unfortunately, against sound advice, the US has opted for a trade war by imposing a 25 per cent import tax on US$50 billion of Chinese imports. China has immediately announced retaliatory tariffs in equal measure which will certainly damage the US economy.

It is bad enough for the rest of the world when elephants make love; it is far worse when they make war, especially when it is the two biggest elephants in the herd.

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