Trade can Help Combat Recession

By: Manoj Pant

It is certain that a full blown global recession is now on.The indicators are too stark. Stock markets, prices and outputs are downeverywhere without exception indicating a general global contraction of demand.At the same time unemployment is up everywhere and rising. Even in the US where wages and prices tend to react quickly to demand and supply there is no respitewith unemployment levels crossing 8%: a level never reached after World War II.

So now it's not about just a sub-prime crisis or a financialcrisis of banks due to a faulty regulatory structure though this might havehelped things along. The world is contracting in real terms and it is time toread John Maynard Keynes not Milton Friedman.

Some commentators have linked the recession to last year'sspurt in oil prices, like in the 1970s when a sharp rise in oil prices between1971 and 1979 sent the economies of the OECD countries into a tailspin. A minorrecession did occur in the developed countries in the first few years of the '80s.But at that time the world went through what we now know was a structuraladjustment. There was a transfer of purchasing power from the developedcountries to the oil producers.

But that time also saw a boom in all commodity prices (notonly oil) and some of the new liquidity of banks found its way to LatinAmerican countries. Today, commodity prices are also headed downward and banksare lending to no one. Clearly, the only recent parallel to today can be foundin the Great Depression of the 1930s.

So the current crisis cannot be a developed country (DC) vs.less developed country (LDC) issue. This was certainly relevant in the 1970sand reflected in the trade negotiations of the Tokyo round of GATT. But this isnot where the answer lies today. A serious reading of Keynes (something I havebeen arguing in the last few months in these columns) would indicate that allcountries must act together to tackle adverse expectations by 'pump priming'world demand. Mere reform of the regulatory system in financial markets (thoughessential) will not solve the present problem.

One good way to look for a Keynesian solution is to think ofthe world as one single country faced with demand contraction. Then we have twohalves of this economy: the developed world with excess consumption (inrelation to incomes) and the developing world with excess saving. Presentlybetween the US, EU and China roughly about $2 trillion of pump priming is inplace (some having been undertaken by the former US administration). However,much of this expenditure is based on domestic deficit financing which maycreate problems in the future.

The solution also lies in trade. As elementary trade theorytells us, the main reason why a country exports is to import. In other words,exports are an expression of a countrys demand for products of other countrieswhich it cannot efficiently produce itself. In an ideal situation no countryshould run trade surpluses (deficits). Hence trade surpluses constitute apotential demand for future imports and withdrawal from current demand.

The accompanying table shows that developingcountries like China have been running huge trade surpluses and much of thisaccretion to reserves has come in 2007 itself. Since these reserves are only apotential demand, running them down provides a perfect Keynesian solution tothe present crisis. In fact, as the accompanying table indicates, China and Japan alone have a potential demand of almost $3 trillion. Running down these reservesthrough expanded imports of these countries would create additional demandwithout too much financial pain.

It is useful to note that the Word Economic Forum (WEF) made one useful suggestion in its annual meeting this year: countries should work to complete WTOs Doha round of trade negotiations. Expanding trade is generally a good idea and especially in today's Keynesian world. This solution would also avoid a repetition of the mistake made during the Depression of the 1930s.

The purpose of economic development should be to improve the standard of living by providing greater access to goods and services. Yet, when a country runs large trade surpluses it effectively uses its production of goods and services to improve the standard of living of residents of another country and accumulates in return paper money which is useless. The mercantilists were wrong 300 years ago. They are also wrong today.

Written by Manoj Pant who is Professor for Centre for International Trade and Development, JNU

Originally published in "The Economic Times" dated March 13, 2009, Ahmedabad