Beware of Wounded Lions

CAMBRIDGE- G-20 leaders who scoff at the United States' proposal for numerical trade-balance limits should know that they are playing with fire. The US is not making a demand as much as it is issuing a plea for help.

According to a recent joint report by the International Monetary Fund and the International Labor Organization, fully 25% of the rise in unemployment since 2007, totaling 30 million people worldwide, has occurred in the US. If this situation persists, as I have long warned it might, it will lay the foundations for huge global trade frictions. The voter anger expressed in the US mid-term elections could prove to be only the tip of the iceberg.

Protectionist trade measures, perhaps in the form of a stiff US tariff on Chinese imports, would be profoundly self-destructive, even absent the inevitable retaliatory measures. But make no mistake: the ground for populist economics is becoming more fertile by the day.

The new US Congress is looking for scapegoats for the country's economic quagmire. And, with a president who has sometimes openly questioned rigid ideological adherence to free trade, anything is possible, especially in the run-up to the 2012 presidential election. If trade frictions do boil over, policymakers may look back on today's "currency wars" as a minor skirmish in a much larger battle.

In light of America's current difficulties, its new proposal for addressing the perennial problem of global imbalances should be seen as a constructive gesture. Rather than harping endlessly on China's currency peg, which is only a small part of the problem, the US has asked for help where it counts: on the bottom line.

True, today's trade imbalances are partly a manifestation of broader long-term economic trends, such as Germany's aging population, China's weak social safety net, and legitimate concerns in the Middle East over eventual loss of oil revenues. And, to be sure, it would very difficult for countries to cap their trade surpluses in practice: there are simply too many macroeconomic and measurement uncertainties.

Moreover, it is hard to see how anyone - even the IMF, as the US proposal envisions - could enforce caps on trade surpluses. The Fund has little leverage over the big countries that are at the heart of the problem.

Still, even if other world leaders conclude that they cannot support numerical targets, they must recognize the pain that the US is suffering in the name of free trade. Somehow, they must find ways to help the US expand its exports. Fortunately, emerging markets have a great deal of scope for action.

India, Brazil, and China, for example, continue to exploit World Trade Organization rules that allow long phase-in periods for fully opening up their domestic markets to developed-country imports, even as their own exporters enjoy full access to rich-country markets. Lackluster enforcement of intellectual property rights exacerbates the problem considerably, hampering US exports of software and entertainment.

A determined effort by emerging-market countries that have external surpluses to expand imports from the US (and Europe) would do far more to address the global trade imbalances over the long run than changes to their exchange rates or fiscal policies. Emerging markets have simply become too big and too important to be allowed to play by their own set of trade rules. Their leaders must do more to tackle entrenched domestic interests and encourage foreign competition.

Germanymight rightly argue that it has followed a relatively laissez-faire attitude towards trade, and that it should not be punished, despite its chronic surpluses. After all, it has stood by as the euro has soared recently. Nevertheless, Germany is a huge winner from global free trade, and it is hardly without tools and means to reduce its surpluses - for example, by pressing to de-regulate its highly rigid product markets.

Given all its recent economic challenges, it is remarkable how, so far, the US has remained steadfast in its support of free trade. Even in cases where its rhetoric has sent mixed messages, US policies have been decidedly liberal.

Consider the long-suffering US-Colombia free-trade negotiations. Although one would never know it from listening to the Congressional debate, the main effect of an agreement would be to lower Colombian barriers on US goods, not vice versa. Colombian goods already enjoy virtual free entry to the US market, while Colombian consumers would benefit enormously if their country were to reciprocate by opening its markets to US goods and services. This has not happened - one of countless examples of obstacles faced by US companies around the world. All should be eliminated.

American hegemony over the global economy is perhaps in its final decades. China, India, Brazil, and other emerging markets are in ascendancy. Will the transition will go smoothly and lead to a global economy that is both fairer and more prosperous?

However much we may hope so, the current rut in which the US finds itself could prove to be a problem for the rest of the world. Unemployment in the US is high, while fiscal and monetary policies have been stretched to their limits. Exports are the best way out, but the US needs help. Otherwise, simmering trade frictions could suddenly throw globalization sharply into reverse. It wouldn't be the first time.

Kenneth Rogoff is Professor of Economics and Public Policy at Harvard University, and was formerly chief economist at the IMF.

Copyright: Project Syndicate, 2010.
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