Wednesday, April 09, 2008

Economics 101: Le Monde Diplomatique

Brought to you by the folks at Le Monde diplomatique:

In theory, the United States is all for free trade and is the leading advocate of the system. But, faced with a recession and a colossal trade deficit, it is reconsidering, as everyone knew it would. The US military contract for 79 refuelling tankers, co-produced by European Aeronautic Defence and Space (EADS) at a cost of $35bn, is no exception. US national interests are well protected. This “European” aircraft will be equipped with General Electric engines, produced in partnership with the US company Northrop Grumman and assembled in Alabama. More than half the added value will be generated in the US. Much of the equipment on offer from the main competitor, Boeing – less readily available, with a more limited refuelling capability and range – would not have been produced in the US.

Editorials in newspapers and the business press assure us that it is wrong to take strong measures to protect national companies and their employees. But history shows that most developed countries owe their prominent positions to trade barriers. Britain, France, Korea, Japan and Prussia did not acquire their industrial power by obeying David Ricardo’s law of comparative advantage. And in the 19th and early 20th centuries, when the US had the highest growth rate in the world, its customs tariffs were around 50% (44% in 1913). President Ronald Reagan inveighed against protectionism but set limits on imports of cars, steel, sugar and textiles. His administration increased duties on cars with big engines (by a factor of 11) and on motorcycles, to rescue Harley-Davidson. And it pressured Japan to revalue its currency, just as President George Bush is asking China to do now (1).

The monetary policy pursued by the Federal Reserve with the tacit approval of the White House, although not openly protectionist, has obvious implications for trade. A weak dollar is good for exports and will reduce the impact of the current recession in the US. The European Union is almost alone in calmly allowing central bank policy on interest rates – high interest rates – to threaten major industries established with considerable injections of public money. Groups like EADS are relocating their activities to the dollar zone to escape the dire effects of revaluing the euro (2).

The deal with the Pentagon also has political and strategic implications. What price did Europe have to pay for the honour of refuelling US aircraft with equipment co-produced in the US because the Federal Reserve keeps interest rates down? When it was announced that the contract had been awarded to EADS, Democratic congressman John Murtha complained that the Europeans were not pulling their weight in Afghanistan. By coincidence, President Nicolas Sarkozy is about to send 1,000 more French troops there. Celebrating his new diplomatic entente with Washington, Sarkozy said: “It would have been unthinkable for EADS to win the contract for refuelling tankers in the previous climate of tension between France and the US” (3). Enough said. The Pentagon decision is a superlative lesson in free trade.