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Nationalism is a negative sum game

The Economist has a couple articles on the rise in economic nationalism, which make some important points:

For many in Washington—both Democrats and Republicans—this new [protectionist] approach is common sense. It is, they believe, the only way that America can protect its industrial base, fend off the challenge from a rising China and reorient the economy towards greener growth. But for America’s allies, from Europe to Asia, it is a startling shift. A country that they had counted on as the stalwart of an open-trading world is instead taking a big step towards protectionism. They, in turn, must decide whether to fight money with money, boosting their subsidies to counter America’s. If the result is a global subsidy race, the downsides could include a fractured international trading system, higher costs for consumers, more hurdles to innovation and new threats to political co-operation.

The first big crack in America’s commitment to free trade came when Donald Trump levied tariffs on products from around the world. In some ways, though, it is this second crack—the present ratcheting up of subsidies—that hurts more. “Free trade is dead” is the blunt assessment of a senior Asian diplomat in Washington. “It’s basic game theory. When one side breaks the rules, others soon break the rules, too. If you stand still, you will lose the most.”

European officials are outraged:

The angrier reaction in Europe is partly because of its weak position. . . . There is anecdotal evidence that Europe is already losing investment. Northvolt, a Swedish manufacturer, is reviewing its plan for a factory in Germany in favour of its existing American operations. Others will follow.

In theory, our allies could bring a case to the WTO, except that the US has effectively destroyed that organization:

The WTO’s prohibition against subsidies involving local-content requirements is clear. Yet so far there is little appetite for such a challenge. If America were to lose, it could appeal against the ruling, which would in effect bring the case to an end since the WTO no longer has a viable appellate body (thanks to America’s decision to block appointments).

On the other hand, the “senior Asian diplomat” who said, “If you stand still, you will lose the most” was wrong; indeed just the opposite is true:

There is an economic rationale for staying on the sidelines. When America pays for technologies at great cost to its taxpayers, these technologies should, in time, become cheaper for everyone. However much America throws at its companies, it cannot have a comparative advantage in all products. Some officials in Asia cling to the hope that their governments and those in Europe will exercise restraint. “That way all non-Americans could have a level playing field with each other,” says a Japanese official.

But the voices calling for more subsidies seem to be prevailing.

Most politicians don’t understand the economics of subsidies.  It’s not a question of subsidies helping one country and hurting another; all countries suffer.

Here’s what politicians don’t understand.  It is not possible for governments to subsidize “industry” as a whole.  All they can do is boost one industry at the expense of another.  If the US subsidizes industries A, B and C, then we implicitly penalize industries D, E, and F.  Two hundred years ago, Ricardo developed the concept of comparative advantage, which explains why helping one set of industries effectively hurts the remaining industries.  Back in the 1990s, Paul Krugman pointed out that for many people, included even high-level policymakers, “Ricardo’s Difficult Idea” is hard to grasp.  Policymakers view the world in partial equilibrium terms when they need to look at things from a general equilibrium perspective.

Every time we put a tariff on steel or aluminum imports, we give a cost advantage to Asian and European firms that use steel and aluminum, such as carmakers.  Every time we subsidize US chipmaking, we give a boost to Asian and European firms that do not make chips.  

Unfortunately, it’s not a zero sum game—industrial policies are negative sum.  In another article, the Economist points out that these subsidies reallocate global production in a highly inefficient fashion:

By our calculation, duplicating the world’s existing stock of investments in semiconductors, clean energy and batteries would cost between 3.2% and 4.8% of global GDP. . . .  Countries like China and Russia do present a profound threat to the current global order. Russia’s curbing of gas exports to Europe in response to European support for Ukraine highlights the risks of relying on such places for crucial imports. The urge among Western democracies to hobble adversaries economically to diminish such dangers is understandable. But it will have huge costs. What is more, the economic policies being adopted in the name of national security and competitiveness are so sweeping and clumsy that they are hurting allies as much as enemies. The zero-sum mindset may or may not succeed in making the world safer for democracy. But it will certainly make the world poorer. [Emphasis added]

I give credit to Treasury Secretary Janet Yellen.  If I had to sit in a room and listen to the economically illiterate views espoused by President Biden’s more nationalistic policy advisors, I would lose my cool.  I don’t know how she puts up with it.

PS.  You might say to yourself, “Sure the policies have some problems, but they can be fixed.”  Nope.  Too late:

President Biden suggests America “never intended to exclude folks who were co-operating with us”. Practically, though, it is not easy to recraft the rules. Legislation was written precisely, specifying amounts, timelines and conditions. Congress would need to pass formal amendments—a tall order at the best of times and inconceivable when the House of Representatives is dysfunctional. 

Rayna Prime

Rayna Prime

Rayna Prime Editor