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The growth illusion behind populist platforms

BLOG - 4 mai 2017

 

Eric Chaney, Economic Advisor at Institut Montaigne analyses this week Marine Le Pen's economic agenda.

Populist politicians, from Marine Le Pen in France to Donald Trump (when he was campaigning) and Cinque Stelle in Italy, have built their economic platforms on a common set of assumptions. They posit that sluggish growth and unemployment are caused by unfair trade and thus that erecting barriers would deliver higher national income growth. No matter how many times mainstream economists may repeat that history has taught us the hard way how very wrong this is; they are hardly being heard. Although there are many reasons for that, starting with the dramatically underappreciated political backlash generated by the 2008-2009 financial crisis, I suspect that there is a deeper root to the nationalistic-populist appeal: the illusion of a come-back of post WWII elevated growth rates, stamped ‘Thirty Golden’ years (les Trente Glorieuses) in France or ‘economic miracle’ (Wirtschaftswunder) in Germany. This cannot and will not happen again, whatever the economic policy implemented in today’s developed countries such as North America, Japan or Europe. To understand why, we need to go back in time.

In 1945, most industrialized countries but the United States had been ravaged by war. Between 1938 and 1946, GDP per capita had fallen by 56% in Germany, 37% in Japan, 25% in Italy and 14% in France. Having massively invested in science, technology and innovation all along the production chains to win the war, the United States had reached an unprecedented level of productivity and welfare. Its GDP per capita had jumped by 50% between 1938 and 1946. At this point in time, US GDP per capita was, compared to Japan, Germany, Italy and France, respectively 540%, 300%, 270% and 140% larger. No wonder that all these countries, able to import state of the art technology and capital from the United States, enjoyed very strong growth rates over the following 30 years. The larger the initial gap, the stronger economic growth: Japan grew faster than Germany, which grew faster than Italy, which grew faster than France. The true name of these miracles was ‘technological catching-up’. Of course, each country had its own way of managing this historical catch-up. While Germany embraced the principles of the ‘social-market economy’ and bet on free trade to build a strong export sector, France relied on central government planning, large companies benefiting from government orders and being protected by tariff and non-tariff barriers. Japan opted for a mix of German and French ways, with a strong involvement of the government in industrial strategy, epitomized by the role of the Ministry of International Trade and Industry (MITI), a fierce protection of the non-traded sector, services and agriculture, and a strategic bet on exports as a powerful engine for capital accumulation and thus income growth. A model followed later by Korea, Taiwan and China.

To be fair, the German and Japanese export strategies were considerably helped by the very low value of their currencies, which were still stigmatized by the total defeat of their State-controlled war economies, as well as by the financial and military support they benefited from the United States as soon as the Cold War started, that is, the day after V-day. In this regard, neither Great Britain nor even France had the same initial conditions.

Economists have studied the catching-up process and uncovered deep similarities between ‘within-country’ (for instance between states in the United States) and ‘between-countries’ dynamics and found that, once country-specific factors are controlled, the convergence rate between lagging and leading economies is surprisingly similar across constituencies, that is around 2% per year.

Of course, this leaves open the question: why did the United States also enjoy relatively strong growth in the 1950s and 1960s, slightly above its secular 2% rate? The best explanation is the accumulation of scientific and technological (S&T) innovation in war time, thanks to massive government and private investment, which percolated through the economy in the decades after the war. Weaker replica of the extraordinary investment in S&T carried out during WWII came off with the US investments to win the Cold War, from Kennedy’s ‘new frontier’ and moon shot strategy to Reagan’s Strategic Defense Initiative, also known as ‘Star Wars’.

That was before. By the mid-1970s, most industrialized countries had by and large caught up with the United States (with an intriguing residual gap of around 10%) and, by 2008, the United States seemed to have exhausted the fuel generated by its technological achievements during the Cold War. Globalization, corresponding to the opening of national borders to trade and capital flows, started in 1947 with the first multilateral trade agreement (GATT) and has followed its course since then. Globalization was geographically boosted by the collapse of the Soviet system and, more importantly, by China embracing the path of economic reforms advocated by Deng Xiaoping and joining the WTO in 2001. Consequently, if some structural changes occurred at the beginning of this century, these were not caused by globalization per se but, rather, by the size of the new players in the global economy.

This brings us back to the populist-nationalist explanation of today’s world shortcomings. Just like President Hoover thought that the best way to check the depression that had engulfed the US economy in 1930 was to insulate it from ‘unfair competition’ from abroad and raised tariffs on more than 20,000 goods imported by the United States, today’s populists believe that protectionism would bring back growth and jobs. The reality is that the reverse would happen: just as in 1930, growth would nosedive and incomes would shrink, following the contraction of global trade, which is the name of foreign demand, seen from the shores of any exporter.

And there is more: protectionism would not only arithmetically reduce global demand but also have a negative impact on productivity and therefore income per capita. This important point, developed by a new generation of trade economics theorists, has profound implications and can be partly grasped through a topical example. According to their professional unions, farmers in both the European Union and Canada have negative views on CETA, the trade agreement negotiated between the European Union and Canada, which Marine Le Pen would reject were she to be elected. That farmers on both sides are unhappy with the deal provides evidence that consumers would benefit from the agreement. Overall, if CETA is enforced, consumer spending would increase, as the agriculture sectors of both regions would become more efficient under the pressure of increased competition. In the theoretical framework called ‘New Trade Theory’, Marc Melitz of Harvard University and other economists have shown that opening borders eventually leads to higher productivity because less productive companies facing more intense competition are outpriced by more productive and efficient companies, allowing the latter to benefit from more capital and thus grow faster, but also because this Darwinian process opens the market to new and more innovative entrants. Needless to say, these results also work the other way round: more protectionism would make life easier for less competitive companies, especially if they expect the government to devalue the currency in case of difficulties, and overall productivity would regress.

Only another large-scale accumulation of scientific and technological innovation shouldered by public investment and free competition between innovating companies could rekindle the growth rate of income per capita. The rapid pace of scientific and technological innovation coming from digitalization, computer science and their brainchild, artificial intelligence, from breakthroughs in materials science and genetics may be nurturing a third industrial revolution, as Erik Brynjolfsson and Andrew McAfee of the MIT believe (2), but this is debated (3) and, if correct, has still to bear tangible fruit. If anything, a more protectionist world would nip in the bud the coming-off of new technologies and preclude their welfare implications.

The populist-nationalistic call is essentially built on a misunderstanding of the economics of free trade – it is a positive-sum game, as new trade theories have documented—and on a time illusion – the possibility of a return of the post WWII economic miracles. The difficulty for reformist politicians such as Emmanuel Macron, who are willing to address structural flaws ailing their countries within the current free trade framework, is that it is politically much more difficult than to tell citizens, “let’s protect our jobs and growth will come back, like in the 1960s”, and do nothing to make the economy more efficient. That is why it is important to unveil the illusion of a possible time travel back to the ‘Golden Age’.

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(1) See ‘Convergence’, Robert J. Barro and Xavier Sala-i-Martin, Journal of Political Economy, 1992, vol. 100 no.2. A convergence rate of 2% per year means that the gap between the leading country and its followers typically shrinks by 2% every year.

(2) See ‘The Second Machine Age : Work, Progress, and Prosperity in a Time of Brilliant Technologies’, W.W. Norton and Company, 2016.

(3) See ‘The Rise and Fall of American Growth’, Robert J. Gordon, Princeton University Press, 2016.

 

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