Mercantilism Works?

from Jim Stanford

I have gathered some interesting comparative information on the recent economic performance of the G7 economies.  My immediate goal was to try to puncture the national “triumphalism” which Canada’s ruling Conservative government has been (wrongly) wielding in an effort to deflect any criticism around Canada’s still-dismal labour market and macroeconomic circumstances. 

While Canada’s financial system was relatively more stable than many other countries through the crisis (mostly thanks to relatively interventionist banking regulations and public supports that pre-date the current Conservative regime by decades), and while Canada enjoyed an initial rebound in late 2009 and 2010 that was relatively vibrant (reflecting mostly a short-lived housing bubble that was ignited by near-zero interest rates, but which is now deflating), the national recovery hit a brick wall in mid-2010.  Job-creation and GDP growth have been nearly non-existent in the last half-year, and Canada now ranks at the bottom of the G7 in per capita real GDP growth over the two most recent quarters.  The Canadian government’s continuing claim that their “sound economic management” somehow puts us in a different category from the rest of the crisis-ridden world, is obviously false.

For a fuller critique of this Conservative triumphalism, see my original post for Canada’s Progressive Economics Forum here.

A couple of points revealed by this comparison of G7 performance, however, might be of interest to international readers, too.  Below are three tables (based on the OECD Economic Outlook database) reporting and ranking the G7 economies according to GDP growth (real and real per capita, 2nd and 3rd quarters of 2010), labour market indicators (unemployment rate, and the change in the employment rate since the recession), and other indicators (3Q 2010 current account balance, 3Q 2010 all-government fiscal balance, and estimated 2010 productivity growth).

Some key conclusions I draw from this data:

1. Population growth rates skew international comparisons considerably.  Canada and the U.S. have much faster population growth than Europe and Japan, and hence need faster GDP and employment growth just to stay even.  This is obviously true with respect to GDP growth.  When the U.S. model was being favourabl compared to Europe’s “sclerosis” in the 1990s, few observers made the adjustment for faster U.S. population growth (which made the per capita comparison considerably less favourable).  The same is true of the Canadian triumphalism today.

The same problem emerges in comparing absolute job-creation.  The Canadian government boasts that Canadian employment has regained (as of August 2010) its pre-recession peak; but with the working age population growing at 1.5% per year, this still leaves Canada in a big labour market hole.  Indeed, measured more appropriately by the change in the employment rate from pre-recession 2008 to the present, Canada’s labour market ranks 5th out of the G7, with only one-fifth of the decline in the employment rate having been offset by the current recovery.  In contrast, Germany and Japan (with no population growth) can more reasonably claim that their labour markets have truly recouped recession losses — in fact, Germany’s employment rate is now higher than it was before the recession (partly thanks to energetic worksharing efforts combined with strong export growth).

2. The unemployment rate is not the best indicator for measuring labour market recovery.  Since labour force participation is declining in most OECD economies, the unemployment rate becomes a less accurate measure of the degree of slackness in labour markets.  Table 2 lists the OECD’s standardized unemployment rates for 3Q 2010.  It also calculates the change in employment rates (as a share of working age population) from 2008 (a broad pre-recession benchmark) to the 3Q 2010.  France has a relatively high unemployment rate, but has experienced a relatively small decline in the employment rate during the recession (indicating stability in labour force participation, and — like Germany — the success of worksharing initiatives).  The U.K. has a lower-than-average unemployment rate, but twice as large a decline in the employment rate (indicating a significant decline in participation).  The U.S., of course, has the worst of both worlds: a high official unemployment rate, but a large decline in participation, which implies two dimensions of labour market malaise; the employment rate is still almost 4 percentage points below pre-recession levels (and as Ben Bernanke admitted last week, that’s not going to change for years).

3. Countries with current account surpluses have achieved the best labour market outcomes.  Japan and Germany are the two G7 countries with current account surpluses (over 5% of GDP for Germany, 3.3% for Japan), and they are the two countries where employment rates are as high (or higher, for Germany) than before the recession.  The countries with the largest current account deficits (U.S., Canada, and U.K.) have experienced the worst decline in employment rates.  Mere coincidence, you say?  I think not.

Beggar-thy-neighbour mercantilism by Germany and Japan (joined by other chronic surplus countries, notably China) clearly “works” in the sense of exporting unemployment to one’s trading partners.  This gives the lie to the high-and-mighty promise by G20 leaders to eschew protectionism during this crisis — avoiding the alleged “errors” of the 1930s.  Whether it’s by explicitly regulating trade (through tariffs or quotas), or through other means of promoting net trade surpluses (like unofficial trade barriers, constraining domestic demand, actively managing exchange rates, or subsidies to export-oriented industries), this temptation to solve one’s problems through export surpluses is still there in an unmanaged, competitive world trading system.  Moreover, it’s all perfectly legal under WTO rules.  These stubborn imabalances expose the myth of mutually-beneficial equilibrating exchange that underlies the current free trade regime.

4. Exchange rate fluctuations have nothing to do with equilibrating current account balances.   This conclusion is well-known in the literature on exchange rates, yet policy-makers still express faith that current account imbalances can be resolved through adjustments in flexible exchange rates.  If that was so, the German and Japanese currencies should be appreciating, and the other G7 currencies the opposite.  Germany’s “currency” has depreciated (thanks to European debt issues).  This is just one of the ways in which Germany is benefiting from the tribulations of its European neighbours, the finger-pointing of the Merkel administration notwithstanding.  (The other way, of course, is through the large trade surpluses which Germany maintains with Greece, Ireland, Spain, and most of the rest of the continent.)  At the other extreme, the Canadian currency has appreciated strongly despite Canada’s record current account deficit.  America’s dollar was weak, but due to financial market sentiments not trade issues.  The exchange rate is a financial variable, not a market-clearing price in real trade and investment markets.  Exchange rate fluctuations will not resolve trade imbalances, and in some cases make them worse.  It will take other measures to resolve large trade imbalances (ultimately involving some sort of global structure to share adjustment burdens); until that happens, the deflationary bias that results from beggar-thy-neighbour mercantilism will continue to undermine recovery.