How and why the tide of globalisation has turned

Politicians banging on about “security” should always be suspected of having ulterior motives, but when you to see the secretary to the Treasury giving a speech on security, that’s when you know the world has changed radically.

That’s what Treasury secretary Dr Steven Kennedy did last week. It was a sign of how much the distinction between economic issues and defence and foreign affairs has blurred as rivalry between the United States and China has grown.

We used to think of “Australia in the Asian century” as one big opportunity for us to make a buck but, Kennedy says, “we are facing a more contested, more fragmented and more challenging global environment, where trade is increasingly seen as a vulnerability as much as an opportunity”.

“In light of these challenges, it is incumbent on Australian policymakers to work together to develop sound policy frameworks and institutional arrangements that match the times. That take the long view and protect both economic and strategic interests,” he says.

We must strike a fine balance, he says. “If we fail to adequately adapt and respond to the new reality we face, we risk exposing our economy and our country to excessive risk...”

But “if we over-correct and adopt a zero-risk approach, shutting ourselves out of global markets and seeking to be overly self-sufficient, we will quickly undermine the productivity, competitiveness and dynamism of our economy,” he says.

Our economy benefited from decades of rising prosperity as international economic integration – globalisation – flourished under a stable, rules-based international order.

At the same time, economic reforms opened our economy to global competition by cutting tariffs (import duties), floating the exchange rate and deregulating the financial system.

But now, “tectonic shifts in the global economic order are underway” as the engines of global growth have shifted from west to east. China has gone from accounting for about 6 per cent of growth in the global economy in 1981, to more than 25 per cent today.

The United States’ share of growth has fallen from 26 per cent to 13 per cent.

However, this move to a more multipolar global order has brought with it “a sharpening of geostrategic [country versus country] competition and a far more contested set of global rules, norms and institutions,” Kennedy says.

As Treasurer Jim Chalmers has said, we are facing “the most challenging strategic environment since World War II” after a difficult decade and a half punctuated by the unmistakable signs of climate change, a pandemic and a European war, which exposed fragilities in our supply chains.

In this changing world, economic resilience – the capacity to withstand and recover quickly from shocks to the economy – is an essential component of assuring our national security.

The trade wars between the US and China during the Trump years have sharpened into an overt strategic rivalry and a contest for global influence.

The US has said it is not seeking to decouple from China – due to the significant negative global repercussions of a full separation – but is “de-risking and diversifying” by investing at home and strengthening linkages with allies and partners around the world.

In this new paradigm, Kennedy says, economic and financial tools are being deployed much more aggressively to promote and defend national interests.

According to the International Monetary Fund, more than 2500 new policies were introduced last year in response to concerns about supply chains, the climate and security. Since 2018, measures restricting trade flows have outnumbered measures that liberalise trade by about three to one.

Our primary economic and strategic (defence) partners are no longer the same. China now accounts for 30 per cent of our two-way (exports plus imports) trade, whereas the G7 countries combined account for just 26 per cent. China is now a larger trading partner than the US for more than 140 countries.

In the new world of greater rivalry, there is a small set of our systems, goods and technologies that are critical to the smooth operation of our economy and to the security of our country. Systems that are vulnerable to interventions and where a disruption could impact lives and threaten our national interest in a time of conflict.

In these parts of the economy there’s a clear role for government in regulating their operation and their ownership. This approach is called the “small yard, high fence” strategy, where a strong set of protections are put around a few critical economic activities.

But the key challenge in these types of reforms is to prevent overreach. The risk of foreign disruption has to be balanced in such a way that economic activity is not unnecessarily curtailed.

And there’s also a different kind of risk: that these types of regulatory regimes could be used as a form of industry protection, or to respond to community pressure, rather than to address genuine security risks.

Whereas our security and intelligence agencies are best placed to understand the vulnerabilities in our systems and the methods most likely to be used to exploit those vulnerabilities – including as part of the foreign investment screening process – they need to be in partnership with economic experts, such as Treasury.

We can’t afford to take the attitude that there should be zero risk of problems, nor dismiss the long-term economic costs of these restrictions.

There should be a high bar for what government puts inside the protected yard and each decision should be carefully weighed, we’re told, with both benefits and costs considered.

As for supply chain problems, it’s often argued that countries should build sovereign capability in areas of risk. This is often argued with little consideration of other ways of solving the problem, or of the cost of doing so.

But as Treasurer Chalmers has made clear, a Future Made in Australia cannot mean pursuing self-reliance in all things. That would undermine our key economic strengths and leave us less able to exercise strategic weight, not more.

Security, it turns out, is too important to be left to diplomats and generals.

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Australia's future to be made under Treasury's watchful eye

The Albanese government’s Future Made in Australia has had a rapturous reception from some, but a suspicious reception from others (including me). In a little-noticed speech last week, however, one of our former top econocrats gave the plan a tick.

Rod Sims, former chair of the Australian Competition and Consumer Commission, and now chair of Professor Ross Garnaut’s brainchild, the Superpower Institute, has been reassured by the plan’s “national interest framework”, prepared by Treasury and issued with the budget.

But first, the budget announced that the government would “invest” – largely by way of tax concessions – $22.7 billion in the plan over the next decade.

Treasury’s framework will be included in the planned Future Made in Australia Act. It will “clearly articulate” how the government will identify those industries that will get help under the act, to “impose rigour on government’s decision-making on significant public investments, particularly those used to incentivise private investment at scale,” according to Treasury.

So, Sims is reassured by the knowledge that the framework – and Treasury – will ensure that “sound economics has been applied”. “In my view, [the plan] represents a growth and productivity opportunity every bit as bold as seen under previous governments,” he says.

Some of those giving the plan a rapturous reception believed it was “a welcome return to activist industry policy and making more things and value-adding in Australia,” Sims says. But “despite what has been said for political reasons, this is not the logic driving [the plan] as described by Treasury”.

Sims says we don’t need to revisit old and tired debates about protectionism. But as it happens, he notes, making more things in Australia will be an outcome of the plan.

Some said the plan represented the end of “neoliberalism” and a return to interventionist thinking. “It is not that either,” he says. “[The plan] relies on sound economics, and any change in economic thinking is a return to the application of sound economics.”

The way I’d put it is that to intervene or not to intervene is not the question. A moment’s thought reveals that governments have always intervened in the economy. (One of the most incorrigible interveners is a crowd called the Reserve Bank, which keeps fiddling with the interest rates paid and received in the private sector.)

No, as we’ll see, the right question is usually whether the intervention is adequately justified by “market failure” – whether, left to its own devices, the market will deliver the ideal outcomes that economic theory promises.

Others have approved of the plan because it’s about encouraging some local production in necessary supply chains. Sims admits there’s an element of this, as local battery and solar panel manufacture are mentioned, but they are a small part of the program.

Similarly, some move to make supply chains less at risk of disruption may be involved, but it’s not the driving logic of the plan.

Yet others have said the plan is copying the United States and its (misleadingly named) Inflation Reduction Act. “This is incorrect,” Sims says. The Americans’ act “spreads money widely, whereas [the plan] is targeted to Australia’s circumstances”.

The US act “also has many destructive features that we will not copy, such as its protectionist approach.”

But, to be fair to the sceptics, he adds, “the policy’s introduction was poorly handled. It was linked to making solar panel modules, when they can be purchased much more cheaply from China, and then there was the announcement of $1 billion for quantum computing.”

“It helps neither global mitigation [of climate change] nor Australian development to force manufacture here, if the final products are produced most cost-effectively elsewhere.”

So, if the plan isn’t mainly about protectionism, what’s its main purpose? Achieving the net zero transition and turning Australia into a renewable energy superpower.

Treasury’s national interest framework says the net zero transition and “heightened geostrategic competition” (code for the rivalry between the US and China) are transforming the global economy.

“These factors are changing the value of countries’ natural endowments, disrupting trade patterns, creating new markets, requiring heightened adaptability and rewarding innovation,” the framework says.

“Australia’s comparative advantages, capabilities and trade partnerships mean that these global shifts present profound opportunity for Australian workers and businesses.” We can foster new, globally competitive industries that will boost our economic prosperity and resilience, while supporting decarbonisation.

In considering the prudent basis for government investment in new industries, the framework will consider the following factors: Australia’s grounds for expecting lasting competitiveness in the global market; the role the new industry will play in securing an orderly path to net zero and building our economic resilience and security; whether the industry will build key capabilities; and whether the barriers to private investment can be resolved through public investment in a way that delivers “compelling public value”.

So, that’s quite a few hurdles you have to jump before the government starts giving you tax breaks. And proposals will be divided between two streams: the net zero transformation stream and the economic resilience and security stream. We can only hope that a lot more of the money goes to the former stream than the latter.

To justify government intervention, the framework requires evidence of “market failure” such as “negative externalities” that arise because the new clean industry is competing against fossil fuel-powered industries which, in the absence of a price on carbon, haven’t been required to bear the cost to the community of the greenhouse gases they emit.

Another case of market failure are the “positive externalities” that arise when the first firms in a new industry aren’t rewarded for the losses they incur while learning how the new technology works, to the benefit of all the firms that follow them.

Politicians being politicians, I doubt whether Treasury’s policing of its national interest framework will ensure none of the $22.7 billion is wasted. But we now have stronger grounds for hoping that Treasury’s oversight will keep the crazy decisions to a minimum.

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Globalisation has stopped, but it's not actually reversing - yet

In case you’ve been too worried about your mortgage to notice, the era of ever-increasing globalisation has ended. There’s a backlash against greater economic integration and a risk it will start going backwards, causing the global economy to “fragment”.

The process of globalisation involves the free flow of ideas, people, goods, services and financial capital across national borders, leading to economic integration. But, as a new post on the International Monetary Fund’s blog site reminds us, globalisation is not new, and the process has ebbed and flowed over many decades.

The post charts the progress of globalisation back more than 150 years. Using openness to international trade – measured as global exports plus imports as a proportion of world gross domestic product – it divides that period into five successive eras.

First came the era of industrialisation between 1870 and 1914, when increasing trade between Europe and the “new world” of North America, Argentina and Australia was driven largely by technological advances in transportation – including steel-hulled, steam-driven ships and refrigeration for shipping meat – which lowered the cost of trade.

The laying of undersea cables to improve communication between countries also helped.

Then came the era of wars and protectionism, beginning with the start of World War I in 1914 and finishing with the end of World War II in 1945.

In between came the Great Depression of the 1930s, which was made much worse than it needed to have been by governments trying to protect their domestic industries by using high import duties (“tariffs”) to keep people buying local.

It sounds like a great idea when you do it to other countries. It turns into a stupid idea when they retaliate and do it to you, leaving everyone worse off.

After trade had increased from 30 per cent of world GDP to more than 40 per cent during the era of industrialisation, it had fallen back to about 15 per cent by the end of World War II.

Third came the era of tariff reform between 1945 and 1980. Even before the war had ended, the Allies knew they’d have to fix the world economy. They decided to move to a system of fixed exchange rates and establish the IMF and the World Bank. Most importantly, they set up the General Agreement on Tariffs and Trade (now the World Trade Organisation).

The GATT arranged eight successive “rounds” of multilateral trade negotiations, in which the developed countries agreed to big reductions in their barriers to imports. Thanks to all this, trade doubled from 15 per cent of world GDP to 30 per cent.

This led on to the era of “hyperglobalisation” between 1980 and 2008, with the fall of the Berlin Wall in 1989 and collapse of the Soviet Union, bringing the Cold War to an end.

The eighth, biggest and final, “Uruguay” round of the GATT, in 1994, focused on increasing trade between the developed and developing countries, with many poor economies joining the WTO.

China’s economy began growing rapidly after it was opened up in the late 1970s, and in 2001 it was permitted to join the WTO, hugely increasing its trade.

The era also brought a move to floating exchange rates and deregulation of banking systems, leading to much increased investment between rich and poor countries.

As well, big advances in telecommunications, computerisation and the advent of the internet allowed a surge of trade in digital services, including data processing.

Resulting from all this, trade reached a peak of more than 55 per cent of world GDP in 2008, on the eve of the global financial crisis and the ensuing Great Recession.

The IMF bloggers label the present period, with figures from 2008 up to 2021, the era of “slowbalisation”. To date, those figures bear this out: trade has reached a plateau of about 55 per cent. More recent figures show world trade has largely bounced back from the initial effects of the pandemic’s global coronacession.

It seems the combined effect of the Great Recession and rising protectionist sentiment has stopped trade from continuing to shoot up relative to world GDP, but not caused it to fall back – or not yet.

Less optimistic observers, however, refer to present as the era of “deglobalisation”. They worry that we’re in the early stages of a period of “policy-induced geoeconomic fragmentation”.

It’s not hard to see what’s worrying them. First we had Britain deciding to leave the European Union, then the election of Donald Trump, vowing to “make America great again” by whacking up tariff barriers against the exports of friend and foe alike, and starting a trade war with China.

Now we have the use of trade and other economic sanctions by many countries to punish Russia in its war against Ukraine, which is fragmenting world trade.

US President Joe Biden has toned down his predecessor’s excesses, but not abandoned the trade war. This doesn’t seem to be about protectionism so much as America’s desire not to be overtaken by China as the world’s dominant superpower. In particular, the US wants to stay ahead of the Chinese in advanced digital technology, by denying them access to the latest and best semiconductors.

The risk is that the two could end up dividing the global economy into separate trading blocs, America and its democratic friends versus China and its autocratic friends. This would almost certainly slow the economic growth of both groupings.

And, as economist Dr John Edwards has written, dividing the trading world into good guys and bad guys would not suit us, nor our region. Our exports to China greatly exceed our exports to the US and other close security allies.

And all the East Asian economies – including Japan and South Korea – have China as a major trading partner. For that matter, China and the US are major trading partners of each other.

Fortunately, and despite all the sparring we’ve seen, Edwards and others find no evidence that the US and China have yet started to “decouple”.

Let’s hope economic sense prevails, and it stays that way.

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Wars, floods and pestilence: these horrors have an economic upside

By profession, economists are hard-nosed and cold-blooded. The pictures we’re seeing of the death and destruction wreaked by Russia in its invasion of Ukraine are heart-wrenching. At home, seeing people perched on their roofs as floodwaters surge, or piling up the ruined contents of their homes on the footpath, makes your heart go out. But what economists see is that every disaster has its upside.

Once they’ve put on their professional’s hat, economists don’t see evil, or pain or any emotion. Feelings must be suppressed when what they need is objectivity.

They simply size up wars and natural disasters for the effect they’ll have on the economy, measured by inflation, unemployment and, above all, gross domestic product. And since GDP often ignores the destruction of buildings and other assets, but plays close attention to the building of new assets, it tends to paint an overly favourable view of events we see as disastrous.

This doesn’t make GDP an instrument of evil that should be banished. It’s simply mono-dimensional. It focuses on a vital, but narrow aspect of our lives – how much we produce, how much income we generate – while studiously ignoring all the other aspects.

When someone’s house has been declared uninhabitable, you and I see how painful and disorienting that must be for them. What an economist sees is all the jobs that will be created and income generated to build them a new one.

But until then, the family will be homeless! That’s OK. Those who provide them with somewhere to live will be earning income and employing people – provided they don’t just stay with family or neighbours. It’s not counted in GDP if no money changes hands.

GDP doesn’t measure wellbeing – and was never designed to. This is only a problem when people fall into the trap of thinking GDP is all that matters – an occupational hazard for economists.

Last week’s budget papers discussed the economic consequence of the war in Ukraine and the floods in NSW and Queensland. For such terrible events, the tone was surprisingly upbeat.

Combined, “the Russian and Ukrainian economies comprise less than 3 per cent of global GDP and less than 2.5 per cent of global trade.

“Foreign financial exposures to Russia are small, and the International Monetary Fund has assessed that sovereign [government] or bank default is not a systemic risk to global financial stability.”

Russia is, however, an important global supplier of rural, mineral and energy commodities. So the invasion has caused substantial disruption in global commodity markets, the papers say, and has the potential to significantly raise inflation and lower global growth.

“Russia produces 18 per cent of the world’s gas and 12 per cent of the world’s oil supply and, together with Ukraine, accounts for around 25 per cent of world wheat exports.” The invasion has increased the risk of supply disruptions, pushing up energy, agricultural and metals prices.

“Global supply chains are also reliant on Russian metals exports, especially palladium [a rare metal used in catalytic converters of exhaust fumes, and fuel cells], so significant supply disruption could have flow-on effects for global manufacturing supply chains.”

All economies will be affected by the rise in global commodity prices. Among the worst affected will be Europe, Japan and South Korea, which are highly dependent on imports of energy. These and other countries will suffer what economists call a “negative terms-of-trade shock” – that is, the prices of their energy imports will rise relative to the prices they get for their exports.

But, the papers say, a smaller set of countries will benefit from a “positive terms-of-trade shock” – because they are net exporters of the higher-priced energy commodities. Their consumers and businesses will pay the higher world price for the petrol and other fuels they use, but this will be greatly offset by the higher prices their producers of energy exports will be receiving.

Among this small group is one lucky country whose net energy exports are twice as great as its domestic energy use. It’s Austria. Sorry, make that Australia. As the economist Chris Richardson might say, you may be paying a lot more for your petrol, but the economy’s been kicked in the backside by a rainbow.

Turning to our floods, although it’s still raining and too soon for final figures, last week’s budget papers say that, under an arrangement where the federal government funds up to 75 per cent of the assistance provided by the state governments, the feds expect to pay more than $2 billion for income support to households, temporary accommodation and social services, about $600 million for community clean-up and recovery, and almost $700 million to businesses and farmers for repairs, new equipment and support services.

As well, the budget makes provision for $3 billion in further federal spending over the coming four years.

Moving from the budget to the economy, we’re told that the “direct economic cost” – that is, those purely monetary costs that show up in GDP – are expected to subtract about 0.5 percentage points from the growth in the nation’s real GDP during the March quarter.

What are the costs that show up in GDP? They’re mainly reduced production in the mining, agriculture, accommodation and food services, retail trade and construction industries.

You’ll be relieved to hear, however, that this 0.5 per cent overstates the net impact of the floods on real GDP over the longer term.

Why? Because “this direct cost will be partially offset by increased investment to replace and rebuild damaged housing, infrastructure and household goods”.

And here’s some good news: the reduced exports of coal caused by rain in the March quarter aren’t expected to be as bad as previous weather events, such as the floods and Cyclone Yasi in 2011.

If you find all this mercenary and distasteful, it’s not new. The arrival of World War II helped end the Great Depression. And rebuilding bombed out Europe and Japan after the war helped the rich countries grow faster than ever before – or since.

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Our dealings with the world have reversed, for good or ill

One of the most remarkable developments in our economy in recent times is also the most unremarked: after endless decades of running a deficit on the current account of our balance of payments, for the past two years we’ve been running a surplus. Which looks likely to continue.

Because a “deficit” sounds like it’s a bad thing, and the media know their audience finds bad news much more interesting than good news, I guess it’s not so surprising this seemingly good news hasn’t attracted much attention.

But one thing economics teaches is that, contrary to popular impression, not all deficits are bad and not all surpluses are good. It depends on the circumstances. But regardless of whether they regard a current account surplus as a good sign or a bad one, I suspect most economists think there are more important issues to worry about.

This week the Australian Bureau of Statistics revealed a record trade surplus of $10.5 billion in just the month of June.

We recorded a current account surplus of $17.6 billion during the March quarter this year. That compares with a peak deficit of $23.5 billion in September quarter, 2015.

Since the bureau started publishing the figures in 1959, we’ve run 221 quarterly deficits, but just 26 surpluses. Eight of those have come over the past two years.

But let’s start at the beginning. A country’s “balance of payments” is a summary record of all the transactions during a period of time between, in our case, an Australian on one side and a foreigner on the other. Those on either side could be businesses, governments or individuals. Mainly they’re businesses.

Conceptually, the balance of payments is recorded using double-entry bookkeeping, where one side of the transaction is recorded as a debit and the other as a credit. So, when you add up all the debits and add up all the credits, the two amounts should be equal. Thus the balance of payments is in balance at all times.

This matters because the balance of payments is divided into two main accounts, the “current account” and the “capital and financial account”. The value of transactions involving exports or imports of goods and services goes in the current account, as do payments – in or out - of income such as interest and dividends.

But the other side of each of those transactions involving exports, imports or income payments, the amount someone has to pay – the financial side of the transaction – goes in the capital account, as do purely financial transactions, such as when one of our banks borrows from or lends to some overseas bank, or when one of our superannuation funds buys or sells shares in a foreign company.

Bear with me. The income we earn from foreigners who buy our exports or pay us dividends or interest is recorded as a credit, whereas the money we pay to foreigners for our imports or as dividends on the Australian shares they own or interest on the money they’ve lent us is recorded as a debit.

When we sell them shares in an Aussie business, borrow from them or sell them some real estate, that’s a credit in the capital account. When they sell us shares or land or lend us money, that’s recorded as a debit.

An account where the debits exceed the credits is in deficit. When the credits exceed the debits it’s in surplus.

There had to be a reason for explaining all this, and we’ve reached it. Historically, we almost always imported more than we exported, running a deficit on trade in goods and services. Likewise, we always had to pay more in dividends and interest to foreign owners and lenders than they had to pay us on our foreign shareholdings and loans to them, thus causing us to run a “net income deficit”.

Put the trade deficit and the net income deficit together and you get the balance on the current account, which was always in deficit. Oh no!

But here’s the trick. Since the double-entry system means the debits always equal the credits, if we always ran a deficit on the current account of the balance of payments, that means we always ran an equal and opposite surplus on the capital account. Yippee!

So if you think it’s good news that our current account is now in surplus, what do you think of the news that our capital account is now in deficit? Time to stop assuming all deficits are bad and all surpluses good.

In all the decades that our current account was in deficit, economists never thought that a bad thing. They knew Australia was – and should be – a “capital-importing country”. We always had a lot more investment opportunities than we could finance with our own saving, so we invited foreigners to bring their savings to Oz to participate in our economic development.

This continuous inflow of foreign capital gave us a continuous surplus on the capital account and thus allowed us to import more than we exported. Naturally, we had to pay big dividends and interest to those foreign investors.

So, why has all that reversed? Well, the reversal began in about 2015, long before the pandemic. Its first main cause is the rapid industrialisation of China, which has greatly increased our exports of minerals and energy and, until the pandemic, education and tourism.

But a second, less-favourable development has been our part in the rich economies’ slowdown in economic growth since the global financial crisis in 2008. This has involved increased saving and reduced investment spending – both of which have helped move our current account towards surplus and our capital account towards deficit.

Economists at the ANZ Bank predict the current account will fall back towards balance over the next few years. But we won’t return to our accustomed capital-importing status until we and the rest of the rich world escape the present low-growth trap.

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Reality is catching up with our freeloading, populist climate deniers

Don’t be taken in by the Morrison government’s outraged cries of “protectionism” against the EU plan to impose a carbon tariff on our exports to Europe. It’s we who are in the wrong, failing to do what we should have to reduce emissions, in favour of politicking and populism.

What we’re seeing is just the reality of the world’s need to act to limit climate change catching up with a government and federal party which, since Tony Abbott used denialism to seize the party’s leadership from Malcolm Turnbull in 2009, decided to make global warming a party-political football: a way to beat your opponents, not a need to tackle the nation’s biggest problem.

It’s a condemnation of our business people that, when their own side of politics offered them a way to postpone the inevitable costs of adjusting to a low-carbon world, they happily embraced it.

It’s a condemnation of Australian voters that they were willing to allow their preferred party to tell them whether they cared or didn’t care about their children’s future. It should have been the other way round. “It’s all too hard; you do my thinking for me.”

But the game has moved on since those bad days, and now it’s not just the rest of the world that’s realised there’s no future in denying the reality of climate change and the need to act. As each day passes, we see more evidence that our own financial regulators, banks, investors and businesses are accepting the inevitable and modifying their behaviour.

All our state governments – most notably the Berejiklian Coalition government of NSW – have embraced the target that all other rich nations have embraced, net-zero emissions by 2050. Everyone can see that our refusal to take climate change seriously is wrong-headed and unsustainable.

So, apart from being a national embarrassment – we’re the person stopped for not wearing a mask, so to speak – it’s no bad thing that even other countries have stepped in to oblige our national government to shoulder its responsibilities.

As part of their plan to reduce their emissions by 55 per cent by 2030, the Europeans are toughening up the emissions trading scheme they introduced in 2005, which imposes a price on the carbon emissions of European industries.

To prevent this putting their industries at a disadvantage against imports from countries that don’t impose a similar carbon price on their own industries, the Europeans plan to use a “carbon border adjustment mechanism”, a tax on imported cement, fertilisers, aluminium and iron and steel to bring their carbon costs up to those faced by local producers.

This not only levels the playing field for local industry, it eliminates the incentive for producers to move their production to countries without carbon pricing.

These problems are ones we ourselves worried about when designing Kevin Rudd’s original carbon pollution reduction scheme (which the Coalition and the Greens voted down in 2010) and Julia Gillard’s carbon pricing scheme of 2012 (which was repealed by Abbott in 2014).

So what the Europeans want to do can’t honestly be called protectionism. It bears no similarity with the new import duties China’s imposing on some of our exports.

What’s true is that it’s a messy but necessary way of solving the “wicked” problem of climate change which, being global, can only be fixed by all of the world’s big emitting countries doing their bit. This is why we can expect many other big countries – starting with America, and maybe extending to Japan − to impose similar carbon border taxes on those countries that try to freeload on those doing the right thing, while helping to sabotage the good guys’ efforts in the process.

So there’s no reason for any of us who believe climate change is real and must be countered to have any sympathy for the Abbott-Turnbull-Morrison government. All its sins of expedience and populist politicking are finding it out. It took a bet that the rest of the world wouldn’t get serious, and we lost.

The point is, had we stuck with either the first or the second version of our own emissions trading scheme – which were actually designed to fit with the Europeans’ scheme – we wouldn’t have this problem.

By now our exporters would be paying our carbon tax to our government (or, if they weren’t yet, we could easily fix it) rather than paying the same tax to foreign governments. Why’s that a good idea?

From the beginning, this government has used climate change as nothing more than an opportunity to attack the other side of politics by pushing populist delusions that taxes are always and everywhere a bad thing. Bad for the economy. Yeah, sure.

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Memo generals: China is our inescapable economic destiny

There must be times in Australia’s history when people look at the nation’s economic experts and wonder if they have any idea what they’re doing. Today, the boot’s on the other foot: people who care about our economic future are wondering what game the nation’s defence and foreign affairs experts think they’re playing.

The concern of many business people and others has been most eloquently expressed by Dr John Edwards, former Reserve Bank board member, in a paper for the Lowy Institute. He’s in complete agreement with Scott Morrison’s assertion last year that “even during an era of great-power competition, Australia does not have to choose between the United States and China”.

Edwards says Australia made its choices long ago, and is now locked into them. “It chose its region, including its largest member, China, as the economic community to which it inescapably belongs. It also long ago chose the US as a defence ally to support Australia’s territorial independence and freedom of action.”

There is a good deal of tension between these two choices, but no possibility that either will change, he says. “Like many other enduring foreign policy problems, it cannot be resolved. It must instead be managed.

“However, it can only be managed if the Australian government has a clear and united understanding of Australia’s interests, and competent people to execute policies consistent with that understanding.”

Australia’s trade with East Asia has been growing faster than its gross domestic product and its trade overall for many decades. Our exports to East Asia now account for more than a sixth of our total GDP. Half of these exports go to China, and now amount to 10 times those going to the US.

Australia is meshed with China’s economy not only because China is such a big market for our exports, but also because China is the major trading partner of our other major markets in East Asia: Japan, South Korea, Taiwan and the ASEAN countries.

Today, East Asia and the Pacific form a regional economic community that, in terms of trade and investment between its members, is only a little less integrated than the European Union, and very much more integrated than the North American region.

“Already selling all it can to Japan and Korea, Australia would not find new markets for iron ore and coal to replace even a part of what it now sells to China. Nor could it easily replace exports of wine, meat, dairy products and manufactures to China. The largest share of foreign tourists is from China, as is the largest share of foreign students,” Edwards says.

“Without trade with China, Australia’s living standards would be lower, its economy smaller and its capacity to pay for military defence reduced.” (Generals – armchair and otherwise – please note.)

“It is difficult to imagine plausible circumstances in which an Australian government would voluntarily cut exports to China. Australia cannot and will not decouple from China’s economy any more than Japan, Korea, Taiwan or Southeast Asia can, wish to, or will,” he says.

Australia’s stance towards the US-China competition must therefore be informed by a recognition that what injures China’s prosperity also injures Australia’s prosperity. Economic "decoupling" of China from North America or Europe is not in Australia’s interests.

But “nor will Australia decouple from its security arrangements with America. The US will remain the primary source of advanced military technology for Australia. It will also remain the primary source of security intelligence.

“And no hostile power can entirely discount that possibility that the US would come to Australia’s military assistance if required. The security arrangements Australia has with America are therefore sufficiently valuable that no Australian government would voluntarily depreciate them, let alone relinquish them.”

The tension between these two pillars of Australia’s engagement with the world will continue for decades to come. The centrality of these relationships makes it all the more important for Australia to conduct them carefully and cleverly, always guided by a notion of Australia’s long-term interests, we’re told.

“China’s growing role on the world stage, its authoritarian government, its suppression of internal dissent, its territorial claims and defence build-up in the South China Sea, together with the deterioration of the relationship between the US and China, make this tension increasingly difficult to manage.

“Thus far, the cleverness Australia increasingly needs is not evident in its handling of relations with China . . . Refusing to take sides in the trade and technology competition between China and the US is Australia’s declared policy. It was wisely adopted – but not deftly implemented,” Edwards concludes, with admirable restraint.

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The last thing we need: neutering the free-trade referee

With the coronavirus putting the world economy into its worst dive in almost a century, it would help if the surviving trade in goods and services between countries was continuing in an orderly way. But, as if we didn’t have enough problems, the future of the international body responsible for ensuring free and fair trade, the World Trade Organisation, is in grave doubt.

The eternal temptation in international trade is protectionism: please buy all our exports, but we’ll be importing as few as possible of your exports. It’s tempting because, to the voters in every country, it seems just common sense to favour your own industries over their rivals in other countries.

Only when you’ve learnt a bit of economics – about the gains from specialisation and exchange, in particular – do your realise that first, it’s the consumers of the protected products and all the local industries you don’t protect who pick up the tab, and second, when you try to steal a march on other countries, they usually retaliate, which ends up meaning you’re both screwed.

That’s why the WTO was set up: to help its 164 member countries reduce their import duties (“tariffs” as economists call them) and other restrictions on imports, and then keep them down, so all the members are better off.

As explained in a report from the Lowy Institute, prepared by Dmitry Grozoubinski, a former trade negotiator with our Department of Foreign Affairs and Trade, the WTO has three main roles.

First, the negotiation of successive “rounds” of mutual reductions in tariffs and import bans or quotas by all the members. After the establishment of the Geneva-based General Agreement on Tariffs and Trade (GATT) after the end of World War II, eight multilateral rounds of reductions were negotiated.

In the early rounds, the members were mainly the developed countries and they concentrated on reducing the tariffs on manufactures that had built up in the 1930s as countries tried to use protection to end the Great Depression, but succeeded only in making it worse.

The result of the rounds was hugely increased trade between the rich countries, which many economists believe contributed greatly to the post-war period of rapid economic growth, rising living standards and full employment, but which ended with the coming of “stagflation” – high inflation and unemployment – in the mid-1970s.

By the “Uruguay round”, completed in 1994, the negotiations had broadened to cover textiles, agricultural subsidies, services and intellectual property. Many developing countries had joined the agreement and benefited from the liberalisation of trade in clothing and textiles, and rural products.

But the round’s most spectacular achievement was turning the GATT into the World Trade Organisation, still based in Geneva. Many more developing countries joined, as did China in 2001.

The WTO’s second role is to monitor member countries’ compliance with the rules agreed on during the rounds. One rule is that once a tariff reduction has been agreed on, it’s then “bound” and mustn’t be increased.

But the most important rule is “most favoured nation”: no other country should be given a special deal. So the lowest tariff you impose on some nation must be the one you impose on every other member. Another key rule is “national treatment”: imported and locally produced goods must be treated equally.

The point of these rules is to keep world trade both free and fair; to discourage countries from backsliding and help governments resist local pressure to revert to protection. In particular, to stop small countries being pushed around by big countries.

And so you see why a middle-size country like ours has much to gain from living in a world where every country sticks to the rules – and much to lose when the big boys on the block decide to start throwing their weight around.

The WTO’s third role is to formally adjudicate trade disputes between its member countries, thereby enforcing its rules. Serious disputes go to a court-like “dispute settlement body” and, if necessary, to an “appellate body”.

So, what’s the problem? Why is the WTO in deep trouble? Because, in Grozoubinski’s words, “all three pillars are wobbly, and had been long before the Trump administration started taking a sledgehammer to them. Unquestionably, however, the picture in 2020 is grim.”

The first role – negotiating further rounds of reduced barriers to trade – is, he says, “hopelessly stalled”. The “Doha round” was launched in 2001, but was unable to reach agreement, partly because it’s much harder for so many developed and developing countries to find common ground. The last attempt to make progress was in 2013.

Meanwhile, countries have shifted from seeking multilateral agreements to doing any number of bilateral (misnamed) “free-trade agreements,” which breach the spirit if not the letter of WTO rules such as “most favoured nation”.

The second role – monitoring members’ compliance with the rules – “relies on international peer pressure for the bulk of its enforcement,” but the world is in the grip of a trade war between the United States and China, meaning the US has gone from decades of getting everyone else to agree on sensible rules and stick by them to ignoring any rules it finds inconvenient in its quest to “make America great again”.

As for the third role – a binding dispute settlement mechanism – in December the US used a procedural blockade to render the WTO’s appellate body “impotent and unable to convene the required quorum of three panellists,” thus rendering the formerly legally binding system of arbitration optional.

If that wasn’t enough, the US is refusing to approve the organisation’s budget, and Congress has bills that would withdraw the US from the WTO (but which are unlikely to be passed). The outfit’s director-general has resigned, and any member could sabotage his replacement. The next conference of trade ministers has been delayed until at least 2021.

And all this is happening at a time of pandemic and escalating protectionism. Well done, chaps.

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Trump's mad trade war has a hidden logic

Simple economics tells us Donald Trump’s stated reasons for starting a trade war with China make no sense. But more advanced economics tells us it’s no surprise he’s 'P’d off' over China’s economic rise.

Trump complains that the United States buys more from China than China buys from the US, meaning his country runs a trade deficit with China. He sees this as an obvious injustice and a sign China is cheating.

But economics teaches that bilateral trade imbalances are natural and normal, the inevitable consequence of countries’ differing “comparative advantage”. (Australia’s strength is rural and mineral commodities, for instance, whereas China’s is manufacturing.)

What matters is a country’s trade with all its trading partners. But, even here, economics teaches it’s not necessarily bad for a country to run an overall trade (or, strictly, current account) deficit.

Why not? Because a country runs a current account deficit when its investment in new homes, business equipment and public infrastructure exceeds its ability to fund this investment with its own saving by households, companies and governments, thus requiring it to call on the saving of foreigners.

Conversely, a country runs a current account surplus when it saves more each year than it needs to fund that year’s investment spending, thus allowing it to lend some of its saving to foreigners.

Because some countries (such as China, Germany) save more than their profitable investment opportunities can take up, they run current account surpluses most years.

On the other side of the coin are countries (the US, Australia) that have more profitable investment opportunities than their savings can cover, so they run current account deficits most years.

Put the two groups together and – at least in theory – the world’s annual saving flows to the most profitable investment opportunities to be found on the planet, thus leaving everyone in the world better off.

But a deputy secretary of the Department of Prime Minister and Cabinet, Dr David Gruen, noted in a recent speech that, at a more advanced level of analysis, some of the recent tension over trade is a consequence of the strong and sustained growth of Asian economies, including China.

“As economies in our region have grown and moved up the value-added chain, they have increasingly competed with more entrenched, influential and valuable industries in advanced countries [such as the US],” Gruen says.

When rapidly developing countries embrace some new technology, the consequent increase in their productivity constitutes an increase in their real income (because they’re producing more output per unit of input).

This should also help raise the income of the developed countries with which they trade, since the rich guys are usually getting access to imports that are cheaper than they can produce themselves.

“While some advanced-country industries [and their workers] have undoubtedly been harmed by a rising Asia-Pacific, a rising Asia-Pacific has also meant more demand for other goods and services from advanced countries [as the developing countries spend some of their higher income on imports from the rich world],” Gruen says.

So better technology and increased trade between the rich and poor countries don’t reduce the real incomes of the advanced countries, but they are likely to change the distribution of income.

More income is likely to flow to the owners of capital and to highly skilled workers, while some lower skilled workers’ real incomes stagnate or fall.

“Such disruption is likely to continue as technology makes it easier to trade services across borders, and economies in the Asia-Pacific become increasingly sophisticated. Some of these newly threatened advanced-economy jobs rely on intellectual property or skills premiums, providing an economic rent worth protecting.

“It is no surprise that the generally open-trade stance of those in places like Silicon Valley sits alongside [Trump’s] demand for strong enforcement of intellectual property rights,” Gruen says.

And, although the rich world is better off with free trade, as technology continues to bring down natural barriers to trade in sectors previously considered “non-tradeable” – particularly services – politically influential opposition to free and open trade is likely to continue, he says.

But there’s a second implication of the economic rise of Asia I bet you haven’t thought of. “It makes less sense for the largest economy in the world to bear the costs of maintaining an open trading system as its economy becomes a relatively smaller share of global output.

“Free trade is a 'public good' – we all benefit from it, but each country has an incentive to shift the cost of maintaining it to others.

“The United States shouldered that burden when it was the world’s largest economy. When you are half the global economy you tend to benefit wherever in the world trade is occurring.

“The logic of [it] continuing to do so is now less compelling. The rules-based [trading] system, including the World Trade Organisation, emerged at a time when the US was the dominant global superpower."

Small or medium-sized economies with limited bargaining power in global markets (such as us) are better off with free trade – even when other countries are being protectionist. Why? Because protecting a few of your industries against imports hurts the rest of your industries more than it hurts the countries whose imports you don’t take.

But that’s not always true for large economies with significant market power, such as the US. They can sometimes use tariffs to drive down the prices other countries charge them for imports.

How? Their market is so lucrative the country supplying the imports absorbs some of the cost of the tariff to keep its retail prices competitive. The lower price of imports across the docks improves the big country’s terms of trade, increasing its real income.

Get it? The US has less to lose from an outbreak of protectionism than do smaller countries like us. That’s why the rest of us have to put more effort into preserving and abiding by the WTO’s “rules-based system” and Trump isn’t quite the madman he seems.

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Both sides of politics play along with costly con trick

Since there’s probably more madness to come, it’s too soon to tell how much Donald Trump’s uncomprehending machinations on trade will do to make America’s economy less great, let alone the rest of us. But it’s safe to predict damage to our economy – much of it self-inflicted.

Yes, self-inflicted. It won’t just be what Trump and others do to us, but also the damage we do to ourselves by hitting back in ways that hurt us more than they hurt the other guys.

By reacting emotionally rather than intelligently. By playing to the peanut gallery.

It’s true that our economy loses when other countries try to reduce their spending on our exports by imposing a tariff (import duty) on their citizens’ purchases of those exports.

But for us to retaliate by whacking a tariff on our imports from them – as is the instinctive reaction of almost everyone – just makes matters worse by requiring our citizens (and businesses) to pay more for those imports.

This gut reaction is prompted by people’s unthinking assumption that exports are good, but imports are bad. When you think it through, however, you realise imports are just as good as exports – why would we be so keen to buy them if they weren’t?

And exports are good mainly because we can use the money we make from them to buy imports.

International trade is an exercise in mutual and reciprocal benefits. They gain from buying our exports; we gain from buying their exports.

The gains are greater the more each side concentrates on exporting the things they’re good at and importing the things they aren’t much good at. That is, from specialising in their strengths, then exchanging with others with different specialisations.

Trying to maximise your exports while minimising your imports is like not wanting to take your turn in a playground game. The others will object and exclude you from the game if you won’t play fair.

But there’s more to it than just fairness to others. By trying to reduce your imports you’re seeking to divert your own resources – land, labour and capital - from producing stuff you’re good at to producing stuff you aren’t good at.

A great way to make yourself poorer rather than richer.

But to get back to where we started, how can I be so sure our politicians would be stupid enough to respond to the folly of others by doing something that would merely increase the cost to us?

Because of the knee-jerk reaction of both the Coalition and Labor when Trump first announced his intention to impose a tariff of 25 per cent on America’s imports of steel.

As Peter Harris, boss of the Productivity Commission, reminded us in a speech this week, “politicians on both sides, along with steel company executives, competed to sound alarms and promote the concept of even bigger price imposts on steel users in this country, all in the name of supposedly saving jobs”.

Apart from asking our best mate Don to exempt our steel from the new tariff (which is what eventually happened), the government trumpeted its willingness to ramp up our “anti-dumping assistance”.

It didn’t mention that this would have been the third ramp-up in decade. A ramp-up of a ramped-up ramp-up.

Not to be outdone, the opposition not only pledged support for tougher anti-dumping measures, it also said it was willing to shift responsibility for reviewing applications for “safeguards” tariff increases from the hard-headed Productivity Commission to some other, soft-headed outfit.

Both the anti-dumping and the safeguards provisions are backdoor ways of using excuses to sneak back-up tariffs you’d earlier reduced.

They’re ways of giving special treatment to our tiny and inefficient steel industry. And, as always, at the expense not just of all Australian consumers of steel products, but all the other Australian industries that use steel as an input to whatever it is they’re producing, possibly for export.

The popular delusion is that higher protection against imports hurts only the countries whose exports we’re trying to keep out. The truth we’re never told about is that the cost of protecting our industry is actually picked up by all our other industries.

Protection doesn’t save jobs, it just attempts to save jobs in the favoured industry by reducing jobs in all other industries. It’s a form of income redistribution from the efficient to the inefficient which, in the process, makes our economy less efficient overall.

Great idea. So why do politicians do it? In Trump’s case, because he’s a fool, and takes no advice from people who are smarter. In the case of our politicians, because they’re knaves: they know (if only because our econocrats keep telling them) that protection is a costly con trick, but prefer to humour popular incomprehension.

In its Trade and Assistance Review for 2016-17, published this week, the Productivity Commission models several “scenarios” that could emerge from Trump’s trouble-making, depending on how we and others respond to his provocation.

It finds that, should no country respond to Trump significantly increasing tariffs on imports from Mexico and China, Australia would be little affected.

On the other hand, should an all-out trade war leave all countries (including us) with tariffs 15 percentage points higher than at present, real gross world product would fall by 2.9 per cent. The fall in our GDP would be less than half that.

Should we hold out from the general increase in tariffs, our gross domestic product would actually be a bit higher than otherwise, though our real national income would be a little worse.

Now get this: should we join with the other members of the Regional Comprehensive Economic Partnership – China, Japan, South Korea, India, New Zealand and the ASEAN countries – in refusing to increase tariffs while everyone else was, the effects of a not-so-global trade war on us would be tiny.

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Why protection from imports isn't smart

With The Donald now busy playing poker with Little Rocket Man, the threat of a trade war has receded. Good. Gives us time to get our thinking straight before the threat returns.

Everyone knows a trade war would be a terrible thing, but most people's reason for thinking so is wrong. This misunderstanding means such a war could happen, even though everyone knows it would be bad.

It seems common sense for a country to want to protect its industry by imposing a tax – known as a tariff or import duty – on imports competing with locally-produced goods. After all, we win and foreigners lose.

The problem arises only if the foreigners retaliate and slap a tariff on our exporters. That's bad for us because it may lead to job losses among those of our workers who earn their living making goods for export.

Is that the way you figure it? Sorry, it may be common sense, but it's wrong. You need to have learnt a bit of economics to see why, because the case against protection is "counterintuitive" – it doesn't seem right, but it is.

The reason people can't see what's wrong with protection is that every baby is born with a disease called mercantilism.

Mercantilism is the belief that exports are good, but imports are bad. Why? Because we – Australia – make money selling exports to foreigners, whereas it costs us money to buy imports, the foreigners' exports.

So mercantilists see Australia as like a company, and our balance of trade as like a company's profit and loss statement. The more you can export and the less you can import – the higher your trade surplus - the richer you become.

What's wrong with that way of thinking? Plenty. For a start, it's the mentality of a miser – someone who loves money for its own sake, not for what it will buy.

Money is just a means to an end, not an end in itself. The economic game is about producing goods and services so we can consume them. Production is the means; consumption is the end. Focus on one at the expense of the other and you've actually done badly in the game.

Similarly, jobs are just a means to an end. Why do people want jobs? So they can earn money and then spend it.

Exports are production, imports are consumption (although much of our imports are of machines we use in the production process). Production without consumption makes sense only to a miser.

Get this: 80 per cent of the way Australia makes its living is by all the workers and businesses and governments producing goods and services and selling them to other Australian workers, businesses and governments, so they can be consumed.

In principle, we could raise the 80 per cent to 100 per cent by only selling to and buying from ourselves. So why do we sell about 20 per cent of the things we produce to foreigners?

Not because it makes us richer, nor because it creates more jobs. It's solely so we can afford to buy some of the goods and services produced by businesses and workers in other countries, when we judge them to be better or cheaper than the stuff made locally.

Exports are good solely because we can use the proceeds to pay for imports – and imports are also good because they raise our material standard of living by giving all of us (workers, would-be workers and dependents) access to goods and services that are better or cheaper than those made in Australia.

If we weren't willing to use the proceeds from our exports to pay for imports from other countries, those countries would refuse to buy our exports.

Refusing to buy our exports would leave those countries worse off (because they'd lose their ability to buy the things we can produce better or cheaper than they can), as well as leaving us worse off because we lost our ability to use our export income to buy their exports.

This, BTW, is why trade wars are mutually self-harming. A group exercise in cutting off your nose to spite your face.

Why wouldn't it be better to be 100 per cent self-sufficient? Because this would limit the benefits to us from "specialisation and exchange". Our domestic economy is organised on the basis that we're all better off if each of us specialises in producing what we're good at, then uses money to exchange what we've produced with what other specialists have produced.

Opening our economy to trade with other countries merely extends this principle, on which we've always run our domestic economy, beyond our borders.

This is why the mercantilists' assumption that trade is a zero-sum game – if you win, I lose – is wrong. Both sides win because both benefit from the "mutual gains from trade".

It follows that the mercantilist notion that foreigners are the only people who lose when we decide to protect some of our industries is wrong. The biggest losers are every other industry and every Australian who loses their access to cheaper or better imported goods and has to pay more for the local version.

That is, tariffs are a tax, not on foreigners, but on Australian producers and consumers. A way of favouring some Australian industries at the expense of all the others. A redistribution of income to favoured industries from those that aren't favoured, and from Australian consumers generally. A form of rent-seeking.

And thus, an attempt to protect some jobs at the expense of all other jobs. Great idea.

Trade wars are destructive not primarily because it's crazy for other countries to retaliate – which it is – but because the country that provokes the retaliation by protecting some favoured industries is damaging itself.

Better to let it stew in its own juice than punish it by harming yourself.

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How we could gang up against a Trump trade war

A possible trade war looms and, as always, an adverse overseas development has caught poor little Oz utterly unprepared. Well, actually, not this time.

Just as Treasury had been war-gaming the next big world recession well before the global financial crisis of late 2008, so the Productivity Commission began thinking about our best response to a trade war soon after the election of Donald Trump.

In July last year it published a research paper, Rising protectionism: challenges, threats and opportunities for Australia, to which Dr Shiro Armstrong, co-director of the Australia-Japan Research Centre, at the Australian National University, made a major contribution. (During a visit to ANU last week I also benefited from discussion with Professor Jenny Corbett.)

Trump's tariffs (import duties) on steel and aluminium were never a great threat to our economy. It'll be only when he decides to take a crack at the Chinese that there'll be a lot to worry about.

But the chest-thumping by our pollies (on both sides) over steel is a demonstration of the way populism can crowd out clear-headed self-interest where protectionism is involved.

Trade wars happen by accident. They start out in a small way, the perceived victims feel their manhood demands they stand up to a bully by retaliating, the bully hits back and pretty soon everyone in the bar is throwing chairs and punches.

As the research paper puts it, "significant worldwide increases in protection would cause a global recession."

Economic modelling by Armstrong estimates that, for every extra dollar by which our revenue from import duties rose, economic activity in Australia would fall by 64¢.

In total, the level of real gross domestic product would be 1 per cent lower each year. This would equate to a loss of about 100,000 jobs. (As with all modelling, take these figures as, at best, roughly indicative.)

A full-blown global trade war would take many months, even years to build up, so how should we respond to the provocative actions of others? What could we do to minimise the damage we'd suffer?

The research paper proposes what economists call a "first-best" response (here I'd call it the What-would-Jesus-do? cheek-turning response): not only should we resist the temptation to retaliate in any way, we should also cut what few remaining protective barriers we have.

If you think that would be plum crazy, you don't know as much about protection as you should. But you've demonstrated why any politician would find such advice almost impossible.

That's why I'm attracted by the paper's second-best suggestion: "working with a coalition of countries to keep their markets open is a strategy that would make it easier for Australia to resist protectionist pressures".

Good thinking. Our leaders want to be seen to be acting to defend our economy, and this response – "let's form our own gang and fight back" - is active rather than passive, and harder to portray as appeasing the bullies.

Oh yeah, what gang? What coalition of countries? That's obvious. We're already a member of a gang that, depending on how you measure it, is bigger than Trump's, or the Europeans'. And our gang's by far the fastest growing.

We do almost three-quarters of our two-way trade (exports plus imports) with Asia – in descending order, China, ASEAN, Japan, South Korea, New Zealand, India, Hong Kong and Taiwan. Europe accounts for only about 15 per cent and Trumpland​ for little more than 10 per cent.

Although it's true Asia needs to trade with North America and Europe, it's also true there's huge trade within our region. Just imagine the damage we'd suffer if we Asians started jacking up tariffs against each other. Or all of us against the rest of the world.

Australia and New Zealand are already members of various Asian trading clubs. And what greater incentive for Asians to pack down more closely than a threat from Trumpland, or from a Europe trying to repel boarders?

Nor is it presumptuous for Oz to take a (quiet) leadership role. Despite all their trade, there's a lot of mistrust between China, Korea, Japan and other countries. China and Japan, for instance, find it easier to work with us than with each other.

After all, we played significant roles in the formation of the Asia-Pacific Economic Co-operation group and in improving the governance arrangements for China's new Asian Infrastructure Investment Bank. We worked behind the scenes with Japan to keep the Trans-Pacific Partnership alive despite Trump's dummy-spit.

And guess what? Malcolm Turnbull will host a summit of the 10 leaders of the Association of Southeast Asian Nations in Sydney next weekend.

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Free-trade agreements aren't about freer trade

You may think spin-doctoring and economics are worlds apart, but they combine in that relatively modern invention the "free-trade agreement" – the granddaddy of which, the Trans-Pacific Partnership, is presently receiving CPR from the lips of our own heroic lifesaver, Malcolm Turnbull.

It's not surprising many punters assume something called a "free-trade agreement" must be a Good Thing. Economists have been preaching the virtues of free trade ever since David Ricardo discovered the magic of "comparative advantage" in 1815.

Nor is it surprising the governments that put much work into negotiating free-trade agreements – and the business lobbyists who use them to win concessions for their industry clients – want us to believe they'll do wonders for "jobs and growth".

What is surprising is that so many economists – even the otherwise-smart The Economist magazine - assume something called a free-trade agreement is a cause they should be supporting.

Why's that surprising? Because you can't make something virtuous just by giving it a holy name. When you look behind the spin doctors' label you find "free trade" is covering up a lot of special deals that may or may not be good for the economy.

This is the conclusion I draw from the paper, What Do Trade Agreements Really Do? by a leading US expert on trade and globalisation, Professor Dani Rodrik, of Harvard, written for America's National Bureau of Economic Research.

Rodrik quotes a survey of 37 leading American economists, in which almost all agreed that freer trade was better than protection against imports, and were in equal agreement that the North American Free-Trade Agreement (NAFTA) to eliminate tariff (import duty) barriers between the United States, Canada and Mexico, begun in 1994, had left US citizens better off on average.

Their strong support for freer trade is no surprise. One of the economics profession's greatest contributions to human wellbeing is its demonstration that protection leaves us worse off, even though common sense tells us the reverse.

And that, just as we all benefit from specialising in a particular occupation we're good at, then exchanging goods and services with people in other specialties, so further "gains from trade" can be reaped by extending specialisation and exchange beyond our borders to producers in other countries.

What surprised and appalled Rodrik was the economists' equal certainty that NAFTA – a 2000-page document with numerous exceptions and qualifications negotiated between three countries and their business lobby groups – had been a great success.

He says recent research suggests the deal "produced minute net efficiency gains for the US economy while severely depressing wages of those groups and communities most directly affected by Mexican competition".

So there's a huge gap between what economic theory tells us about the benefits of free trade and the consequences of highly flawed, politically compromised deals between a few countries.

Rodrik says trade agreements, like free trade itself, create winners and losers. How can economists be so certain the gains to the winners far exceed the losses to the losers - and that the winners have compensated the losers?

He thinks economists automatically support trade agreements because they assume such deals are about reducing protection and making trade freer, which must be a good thing overall.

What many economists don't realise is that the international battle to eliminate tariffs and import quotas has largely been won (though less so for the agricultural products of interest to our farmers).

This means so-called free-trade agreements are much more about issues that aren't the focus of economists' simple trade theory: "regulatory standards, health and safety rules, investment, banking and finance, intellectual property, labour, the environment and many other subjects besides".

International agreements in such new areas produce economic consequences that are far more ambiguous than is the case of lowering traditional border barriers, Rodrik says, naming four components of agreements that are worrying.

First, intellectual property. Since the early 1990s, the US has been pushing for its laws protecting patents, copyrights and trademarks to be copied and policed by other governments (including ours). The US just happens to be a huge exporter of intellectual property – in the form of pharmaceuticals, software, hardware, music, movies and much else.

Tighter policing of US IP monopoly restrictions pits rich countries against poor countries. And though free trade is supposed to benefit both sides, with IP the rich countries' gains are largely the poor countries' losses. (Rich Australia, however, is a huge net importer of IP).

Second, restrictions on a country's ability to manage cross-border capital flows. The US, which has world-dominating financial markets, always pushes for unrestricted inflows and outflows of financial capital, even though a string of financial crises has convinced economists it's a good thing for less-developed economies to retain some controls.

Third, "investor-state dispute settlement procedures". These were first developed to protect US multinationals from having their businesses expropriated by tin-pot governments.

Now, however, they allow foreign investors – but not local investors – to sue host governments in special arbitration tribunals and seek damages for regulatory, tax and other policy changes merely because those changes reduced their profits.

How, exactly, is this good for economic efficiency, jobs and growth?

Finally, harmonisation of regulations. Here the notion is that ensuring countries have the same regulations governing protection of the environment, working conditions, food, health and safety, and so forth makes it easier for foreign investment and trade to grow.

Trouble is, there's no natural benchmark that allows us to judge whether the regulatory standard you're harmonising with – probably America's - is inadequate, excessive or protectionist.

Rodrik concludes that "trade agreements are the result of rent-seeking, self-interested behaviour on the part of politically well-connected firms – international banks, pharmaceutical companies, multinational firms" (not to mention our farm lobby).

They may result in greater mutually beneficial trade, but they're just as likely to redistribute income from the poor to the rich under the guise of "free trade".

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Why global trade growth has slowed

One thing you can be sure of is that international trade grows much faster than the world economy. It's the classic proof of growing globalisation, and it's been happening for ages. Except that it seems to have stopped.

For two decades from the mid-1980s, world trade – measured as exports plus imports – grew at more than double the rate of growth in gross world product.

Between 1986 and 2007, the volume of trade grew at an average annual rate of 3.4 per cent of world real gross domestic product, meaning it went from being equivalent to almost 30 per cent of gross world product to almost 60 per cent.

But then it dipped sharply in 2008 and 2009, thanks to the fall-off in trade after the global financial crisis and the onset of the Great Recession.


It bounced back in 2010 but, since 2011, its growth has been only a little faster than world production of goods and services.

In the decades before 1986, the volume of trade grew faster than production, but at much slower rates than in the two decades that followed. That's how we know to date the modern era of globalisation – the breaking down of economic barriers between national economies – from the mid-80s.

So, why has trade growth slowed so noticeably, and is this merely cyclical (temporary) or is it structural (lasting)?

According to a study by the Organisation for Economic Co-operation and Development, a fair bit of both.

The study estimates that about 40 per cent of the slowdown between 2011 and 2015, as compared with the period from 1991 to 2007, is explained by the weak growth of demand in the global economy.

In particular, the crisis saw a sharp fall-off in businesses' investment spending on new physical capital – which happens to be import-intensive – but it hasn't recovered all that much in the years since then.

But that leaves roughly 60 per cent of the slowdown explained by deeper, more structural forces, ones that won't just go away if we wait a few more years.

Part of the explanation is that, in the two decades before the crisis, certain factors contributed to making trade growth exceptionally strong, but these factors have now lost their force.

The biggest cause of this exceptional growth in trade was various measures to reduce tariff and non-tariff restrictions on trade.

In 1989, and partly at Australia's instigation, the Asia Pacific Economic Co-operation partnership between 21 countries was established to promote free trade.

The European Union moved to a single market in goods, services, labour and capital in 1992, increasing trade between its members. Because Europe consists of a number of separate countries, it's highly (international) "trade intensive" in a way that America – composed of states rather than countries – or even Australia, isn't.

In 1994, the "Uruguay round" of multilateral negotiations – the biggest of the many rounds of reductions in protection organised by the General Agreement on Tariffs and Trade since World War II – was reached.

This round extended membership of the GATT from the developed countries to about 150 developing countries – thus doing much to increase trade between the two groups. It also reached trade agreements covering new areas such as textiles, agriculture, services and intellectual property.

And, for good measure, the round turned the GATT into the World Trade Organisation.

The North American Free Trade Agreement between the US, Canada and Mexico began in January 1994.

And also hugely important to the growth of trade, China – now the world's second-largest trading nation – joined the WTO, cutting much of its protection as a condition of entry.

A second factor promoting the growth of trade in the two decades before the crisis was the widespread development of "global value chains" – value as in "value-added" – under which manufactured goods (cars, for instance) are assembled in one country using parts from many countries.

As trade liberalisation measures slowed in about 2000, continued growth in trade was supported by China's rapid emergence into the world economy.

By the second half of the noughties, however, these structural sources of growth had waned.

In this century, the WTO's Doha round of multilateral negotiations, launched in November 2001, has ground to a halt. According to the study, this halt in liberalisation explains about a quarter of the slowdown in the growth of trade between 2011 and 2015, compared with 1991 to 2007.

Many bilateral and regional trade agreements have been signed since then, but the only really significant agreement, the Trans Pacific Partnership, signed in February 2016, has since been scuttled by US President Donald Trump.

Add to this, "creeping protectionism from myriad small measures" in various countries, which has put trade liberalisation into reverse.

The spread of global value chains seems to have reached its limit, even declined.

Meanwhile, China's period of export-led growth has ended, with its authorities now aiming for growth led by domestic demand.

So what happens next, and what should be done?

The study says some cyclical recovery in the growth of trade is likely but, without further trade liberalisation, a return to the glory days seems unlikely.

"Trade", it reminds us, "and the related expansion of global value chains, boosts [economic] growth through increased productivity, by improving resource allocation, increasing scale and specialisation, encouraging innovation, facilitating knowledge transfer, fostering the expansion of more productive firms and the exit of the least productive ones."

All true. But, as the study acknowledges, the benefits of increased trade aren't spread evenly between or within the countries involved.

As a consequence of this – and the politicians' failure to ensure the losers from globalisation were compensated by the winners – the electorate in many rich countries is "increasingly polarised into pro- and anti-globalisation groups".

We have a lot of ground to make up before much enthusiasm for further globalisation returns.

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Our politicians go populist at their peril

If I were an Australian politician I'd think hard about the ascension of Donald Trump before I drew conclusions for local consumption.

When someone so unattractive surprises us by winning, it's tempting to conclude he must have done so because of a massive surge of anger over immigrants, Muslims and jobs lost through trade agreements.

We connect this with the Brexit surprise and the resurrection of One Nation and conclude we're witnessing a worldwide populist uprising against globalisation and "neo-liberalism".

Pollies on both sides wonder whether they should protect their backs by reverting to more protectionist policies, rejecting more Chinese investment and shouting louder about Australia-first.

But such a reaction much exaggerates the popularity of populism in America – as is clearer now more of the vote has been counted.

First, note that Hillary Clinton got over a million votes more than Donald Trump did. He actually got fewer votes than Mitt Romney in 2012 and John McCain in 2008.

How is such a wide discrepancy between the popular vote and the electoral college result possible? Because the many smaller states get a disproportionate number of votes in the college.

So Trump won because he got more votes in the right places – three or four smaller "swing states" in the midwest Rust Belt, which normally vote Democrat.

It's true Trump won these states because enough white males without college educations found his plain-talking and promise to "make America great again" – that is, bring jobs back to the Rust Belt – more attractive than establishing a Clinton dynasty.

But let's not kid ourselves America is seeing a nation-wide upsurge in populist protectionism, any more than One Nation's ability to exploit an ill-judged double dissolution represents an existential threat to Labor or the Coalition.

Next, remember populist sentiments can't be satisfied. They're about the expression of emotion – anger, frustration, envy, fear of foreigners, resentment of city-slickers and the better-educated – not about rational choices.

They're about wishing the world hadn't changed and wishing some saviour could change it back.

Populism is about ignoring the things that have changed for the good – such as much lower prices for clothes, groceries, hardware, electronic goods, cars and much else – and assuming we can reverse the changes we don't like without losing the benefits we've come to take for granted.

Populism is about explaining the decline in employment in manufacturing, and the shift in economic activity from the Rust Belt to the Sun Belt, solely in terms of free-trade agreements – which were made by governments and so supposedly can be reversed – while ignoring the much greater role played by technological change, which happened in spite of governments and can't be stopped by governments.

It's perfectly possible for America to make no further trade agreements, but only an American could delude themselves that their government could tear up longstanding agreements with other countries while those countries sucked it up.

Protectionist moves lead to retaliation by your trading partners. That leaves both sides worse off.

Consider all the wild promises Trump made to con the Rust Belt's white male workers into voting for him: a wall along the Mexican border, a 35 per cent tariff on Mexican imports and 45 per cent on Chinese imports, plus renegotiation of the North American free-trade agreement.

Assuming he wanted to, he can't actually do these things. Assuming somehow he could, they wouldn't fix the problem the way his dupes imagine, while introducing a new set of problems.

This says it won't be long before the Rust Belt's plain talkers realise they've been conned.

Add to them the majority that didn't want him in first place, and the many who held their nose and voted Republican because they couldn't stomach any Democrat, and it's not hard to see Trump setting records for the time it takes a president to become thoroughly on the nose.

Sound like a winning formula for our pollies to copy? Since populism fosters aspirations that can't be satisfied, it's suited to new, minor parties, but a high-risk tactic for parties that stand a chance of getting to government and having to deliver on the expectations raised.

None of this says the Rust Belt revolters don't have legitimate grievances.

A small group of business heavies and well-educated city-slickers has grabbed almost all the benefits from the structural change that's so disadvantaged the rust-belters, without governments – even Democrat majorities – doing much to oblige the winners to share with the losers.

For once in their lives, rather than going lower when they see the Yanks go lower, our pollies should, to quote Michelle Obama, "go high when they go low".

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Little right, much wrong with Trumponomics

For years I've wondered how America's business elite could grab almost all the proceeds of the country's growth, leaving real wages permanently stagnant, without having ordinary workers rioting in the streets.

Now I know. The anger kept building until a political huckster called Trump found the way to exploit it for personal advancement.

The bitter joke is that the populist promises he made to keep out Muslims, Mexicans and Chinese imports would do little to make the mug punters better off, whereas many of his more conventional economic policies will do much to further fatten the pockets of the 1 per cent the punters so resent.

While we wait to see which promises he acts on, the best guess is he'll implement those of his policies that fit with Republican orthodoxy.

After all, he'll be relying on the usual Republican suspects to make up his cabinet and relying on Republican majorities in Congress to put his policies into law.

This suggests he'll be quick to start phasing corporation tax down from 35 per cent to 15 per cent, and lowering all rates of personal income tax (though not necessarily in a way that favours low and middle earners).

He's likely to increase defence spending and maybe even keep his promise to fund a much-needed urban infrastructure renewal program.

But surely this would cause a huge expansion of the still-excessive federal budget deficit, wouldn't it?

Yes, but that's unlikely to stop it happening. It is, after all, similar to what Ronald Reagan did on coming to office in 1981.

We're about to see confirmation of an eternal truth of American politics: the Republicans care hugely about the evils of debt and deficit – it keeps them awake worrying about what we're leaving for our children and grandchildren – but only when there's a Democrat in the White House.

For the most part it will be a giant exercise in trickle-down economics – even though many of the people who fell for Trump's crude charms now rightly see it for the voodoo economics it mainly is.

Protectionism may be the new saviour – in Nick Xenophon's Oz as well as Trump's Rust Belt states – but it's still the delusion it always was. It seems "only common sense", but that doesn't mean it works.

In any case, were Trump to impose a huge tariff on Chinese imports, do you imagine that would re-open the ghostly steel mills in Gary, Indiana, or the rusting automobile plants down the road from Michael Moore's place in Flint, Michigan?

Turning back globalisation is no easier than turning back time. The main thing you'd do is rob working people (and the rest of us) of access to the one aspect of globalisation they've clearly benefited from: imported goods much cheaper than the locally made goods they replaced.

Don't kid yourself: some lost their jobs in factories, but all workers – most of whom never worked in manufacturing – benefited from lower prices.

That's why there's no free lunch in protection: it's a scheme where the fortunate few are subsidised by the less-favoured multitude. It's not foreigners who lose out, it's other locals.

And don't kid yourself on this: far from all the jobs lost from manufacturing were lost through import competition.

Far more than many oldies realise were lost through computerisation. That's a big part of the reason reimposing high tariffs would do surprisingly little to restore manufacturing employment.

It's a convenient delusion that globalisation is solely the product of "neo-liberal" deregulation. Its other, bigger driver is technological advance and the digital revolution. Think any pollie can stop that?

This isn't to say scuttling the Trans-Pacific Partnership free-trade agreement would be any loss. It offered trivial benefits to us, in return for giving foreign multinationals power to push our government around.

Just because preferential trade deals are called "free-trade agreements" doesn't make them a good thing. The US's primary goal in its many agreements is to advance the interests of its exporters of intellectual property, while continuing to protect its farmers.

Its trans-Pacific deal was intended as cover for the bilateral deal with Japan hidden within it, as well as strengthening America's trading links with all the main Asian economies that weren't China.

The Yanks may be paranoid about the rise of China, but the joke is there never were two big economies – the two biggest – more interdependent. The US is China's largest trading partner, while China is the US's second-biggest – and its biggest creditor.

The Yanks are really stoopid​ enough to take a crack at Chinese imports? Trump is a cunning con man, not an idiot.

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Breaking news: classical Athens had an economy

Did you know that classical Athens didn't have an economy? If you find that hard to believe, you should - because it's not possible.

But if you read the many hundreds of books written about Athens in the classical period, you could be forgiven for imagining that all those philosophers, poets, artists, politicians and generals existed in a world where the mundanities of making a living and raising a family didn't exist.

This may be because the authors of those books thought that, beside the glories of Athens' literature, art, architecture and history, mere economics wasn't worth mentioning. Soo boring, darling.

Or it may be that, in the minds of the authors of earlier centuries - maybe even in the minds of the Athenians themselves - an association with "trade" carried a social stigma. Like using the lavatory, it was a necessary evil not to be mentioned in polite society.

But when Peter Acton, who studied classics at Oxford but ended up as a management consultant, finally got the chance, he decided to search out whatever information he could find to set the record straight and complete the picture of Athenian life.

Athens' classical period ran from the defeat of the second Persian invasion of Greece under Xerxes to when Athens and the rest of Greece came under the control of Alexander the Great. So, the fifth and fourth centuries BCE.

Whatever they did to keep body and soul together that long ago must have been small and primitive, right?

Well, no. Acton found Athens at the time had a large and thriving manufacturing sector, defined broadly to include both mining and construction.

He set out his discoveries in the book Poiesis: Manufacturing in Classical Athens, which I'll summarise. "Poiesis" comes from the same Greek root as "poetry", but means "to make".

It seems the Athenians had a lot of manufactured items in their homes. They were at the stage of economic development where the more accoutrements you could acquire, the better off you were (whereas we're closer to satiation with goods and prefer acquiring experiences).

"Athenian Man was as likely as not to have made many of the products used in his own home and probably depended for a good part of his sustenance on manufacturing for sale," Acton says.

"However rich he was, his wives and daughters would make their own clothes, working alongside some of their slaves and perhaps supervising others in the household's workshop.

"Every time he went outside, he would be surrounded by evidence of production: the smells and the smoke of smithies and pottery furnaces, the clack of looms, the hammering of carpenters and sculptors, carts rattling through the streets full of stone or wood or bales of fine cloth or jars of imported oils."

It seems likely that more than half the city's residents would have spent at least some of their time manufacturing products for sale or home consumption, Acton estimates.

This would involve almost all the slaves, of course, either helping with household production or working in a gang for one owner.

"A reasonable estimate is that around a quarter of the free population of all status levels, men and women, worked at making things," he says.

Manufacturing activity ranged in size. "It is a common mistake to see manufacturing as having undergone a steady progression from self-sufficiency based on home crafts to mechanised mass production.

"In reality, individual craftsmen, small workshops, co-operative production arrangements and large factories have coexisted over millennia in various societies, not least in classical Athens."

Although written accounts of economic life are sparse, archaeological finds are a different matter. Material evidence gives us clues about the occupations followed.

Wood, for instance, suggests foresters, sawyers, carpenters, furniture makers and boat builders. Stone suggests quarrymen, stonemasons, sculptors, mosaicists and haulers.

Metals imply miners, blacksmiths, armourers, silversmiths, goldsmiths and coiners. Clay implies potters and tilers; hides say tanners and cobblers; reeds say rope and basket makers; herbs say healers and perfumers, and wool says fullers, dyers and weavers.

Manufacturing, Acton contends, was the great leveller. Whereas agriculture was real capitalism, contributing to social inequality, trade and industry helped to level income and status.

"The social mobility, employment opportunities and relatively even distribution of wealth that accompanied the rise of commerce helped Athens to avoid the revolutions that the Peleponnese suffered regularly."

By Acton's estimate, the classical Athenians enjoyed a high standard of living - not just compared with other people at the time, but even compared with any other society until recently.

Economic growth in Greece was up to 0.9 per cent a year, twice as fast as in England and Holland before the Industrial Revolution.

By classical times the basic daily wage was about six times that required for subsistence, and half Athens' population lived a life that was better than the typical Briton's in the 18th century.

Conspicuous consumption became increasingly common in the fourth century BCE. "Some couches and tables were highly ornate and inlaid with gold or silver.

"Men and women wore jewellery of outstanding craftsmanship and decorative ceramics or silverware for festivals might take several years of work."

Health, as measured by bone density, increased rapidly, even though urbanisation tends to have the opposite effect.

Houses, though not luxurious, were large and comfortable, typically with roof space larger than the median single detached house in the United States in 1997. The extra space accommodated more furniture and possessions.

Athens engaged in much trade. Massive imports of grain allowed her farmers to pursue their comparative advantage, producing olive oil and wine for export.

They also imported luxury items such as fine cloth, spices, dyestuffs and precious metals, often for further processing in Athens.

But it was rich in raw materials, including marble, limestone, clay and silver.

Sounds like Athenians then were doing better in relative terms than many of them are today.

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