Goodbye, Free Trade; Hello, Mercantilism

Here's today's quiz. What do the following have in common: (a) Vladimir Putin; (b) China's currency, the renminbi; (c) the U.S.-Peru trade agreement; (d) Hugo Chávez. Answer: they all reflect the "new mercantilism." It's a significant and ominous development affecting the world economy. Even as countries become more economically interdependent, they're also growing more nationalistic. They're adopting policies intended to advance their own economic and political interests at other countries' expense. As practiced until the mid- 19th century, mercantilism aimed to do just that.

It was an economic philosophy that favored large trade surpluses. At the time, this had some logic. Trade was an adjunct to military power. Exports earned gold and silver coin, which financed armies and navies. But mercantilism fell into disfavor as a way to promote national prosperity. Free trade, argued Adam Smith and David Ricardo, would benefit all countries, because each could specialize in what it did best—the doctrine of "comparative advantage." The post-World War II economic order took free trade as its ideal, even though trade barriers were lifted slowly. Now mercantilism is making a comeback, as governments try to manipulate markets to their advantage.

The undervalued renminbi is the most glaring example. China's leaders have staked their country's political stability on export-led job creation, driven by an artificially cheap currency that puts competitors—Mexico, India and other developing countries as well as the United States and Europe—at a disadvantage. Naturally, China's trade surpluses have swelled. In 2007, the current account—a broad trade balance—will register a $400 billion surplus, about 12 percent of gross domestic product, up from $21 billion, or 1.7 percent of GDP, in 2000, according to economist Nicholas Lardy of the Peterson Institute. As a share of GDP, China's current-account surplus is "triple Japan's level in the 1980s when Japan bashing was at its peak."

Mercantilist notions also affect the energy trade. "A Bear at the Throat" is how The Economist recently described Europe's reliance on Russia for about a quarter of its natural gas. Putin talks of a world gas cartel, and Europeans fear that their heavy dependence exposes them to political blackmail. Chávez is already less subtle. He dispenses Venezuela's oil to Cuba and other friendly Latin American countries at discounted prices. The specter is that scarce energy supplies, now available to all on commercial terms, will be increasingly allocated by political commitments.

Finally, the retreat from global trade agreements also reflects the new mercantilism. The Doha Round of worldwide trade talks is floundering. Countries feel more comfortable with nation-to-nation and regional agreements, where they have more control over the terms. The World Trade Organization counts more than 400 such agreements; the U.S.-Peru agreement is the latest.

The paradox is that as the Internet and multinational companies strengthen globalization, its political foundations are weakening. Of course, opposition is not new. Even if free trade benefits most countries, some firms and workers lose from added competition. But for most of the postwar era, a pro-trade consensus neutralized this opposition. This consensus is now fraying.

Two powerful forces had shaped it, notes Harvard political scientist Jeffry Frieden. First was the belief that protectionism worsened the Great Depression; the United States and its allies wanted to avoid a repetition of that tragedy. The second was the cold war; trade was seen as a way of combating communism by promoting the West's mutual prosperity. Both ideas bolstered political support for free trade. For years the global trading system flourished on the inertia of these impulses, which now have little practical relevance.

In a booming world economy, the resulting tensions have so far remained muted. China's discriminatory trade practices, for example, have excited angry rhetoric, but not much else. The Chinese have generally deflected protests by announcing large export orders at crucial moments. When European leaders recently visited, there was a placating order for 160 Airbus planes worth an estimated $15 billion.

But would a global economic slowdown change that, if other countries blamed Chinese exports for destroying their domestic jobs? Would import quotas or tariffs follow? Already China has turned from the world's largest steel importer to the largest exporter, says Lardy. In the United States, the present pattern of global trade is viewed with increasing hostility: U.S. deficits are seen as eroding industrial jobs while providing surplus countries with the dollars to buy large pieces of American firms.

The world economic order depends on a shared sense that the system benefits most nations. The more some countries pursue narrow advantage, the more others will follow suit. "What's the glue that holds all this together?" asks Frieden. "Is there a common agreement about cooperation that allows governments to give up something to maintain the international order?" It's an open question whether these conflicting forces—growing economic interdependence and rising nationalism—can coexist uneasily or are on a collision course.

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