In the name of free trade in services and financial liberalisation, the US should not try to rob sovereigns of their policy space.
This article is being written in the backdrop of the disclosure that the previous Indian government might have left itself with no escape clause when it signed the trade agreement in Bali. Instead of a four-year window being given to the World Trade Organization (WTO) to come up with an acceptable formula for calculating reference prices, the agreement appeared to have put the onus on the subsidising governments to find a solution by 2017, failing which they would be found guilty of violating their international commitments on agriculture and food subsidy.
It is clear that developed nations are playing hardball. Economic growth is history in much of the developed world. Hence, developed nations would try to extract as much growth as possible through international trade because their attempt to gain market share is not based on improved competitiveness of their products.
Share of manufacturing has not picked up materially in the US economy. It has perhaps not even stopped declining. Employment generation in manufacturing is conspicuous by its absence. In any case, a manufacturing revival is possible only if businesses are prepared to invest in real assets, in equipment. Even in the headline grabbing second-quarter gross domestic product growth in the US of an annual rate of 4 percent, the share of equipment investment was just 10 percent.
Further, much has been written about the recent improvement in US trade deficit due to declining imports of crude oil and petroleum products. The improvement is marginal so far. Second, excluding petroleum, there is no improvement in its trade deficit. If anything, it has worsened despite record low interest rates aimed ostensibly at boosting investment spending and enhancing domestic production.
In real terms (2009 dollars), the US is on course to record one of its highest trade deficits (excluding petroleum) in 2014. Therefore, the US is trying to bludgeon its way through other markets in services, including financial services. Financial services include banking, insurance and asset management. The baggage of global capital flows comes along with financial services. The Financial Services Annexure to the draft Trade in Services Agreement (TISA) document, released by WikiLeaks, leaves the potential signatories to the agreement with no scope to regulate the entry of Western financial firms into their countries and to restrict their product offerings.
While the US lost its manufacturing competitiveness earlier, it lost its alleged competitive advantage in Services with the onset of the economic crisis of 2008. The weaknesses of the largely unregulated financial system and its inherent instability were brutally exposed. Yet, it is not clear if all policymakers in the US have learnt the right lessons from it. Moreover, the ethical transgressions of the banking sector continue to this day.
Despite this backdrop, the US insists on aggressive opening up of financial markets in the developing world. Notwithstanding the experience of the global financial crisis, provisions on capital flows proposed in the Trans-Pacific Partnership severely crimp the ability of sovereign nations to restrict inflow and outflow of capital in an emergency for a reasonable period.
Further, the spillover from easy money policies of the West stoke credit booms and asset bubbles in the developing world. Their institutions and regulatory framework are not fully adequate to handle these and their fallout. That is not a surprise since even the US seems to be at a loss to handle the political economy of the financialisation. Financialisation reflects the disproportionate influence of the interests of the financial sector in policy decisions. Consequently, financial asset prices influence economic outcomes (instead of asset prices reflecting economic fundamentals) and financial market outcomes heavily household and corporate income and in balance sheets.
The US has to put the genie of financialisation back into the bottle and accept the short-term growth consequences that would arise consequently. It has to recognise the global spillover of its monetary policies. The privilege of being the issuer of the world’s reserve currency and the benefits that accrue from that status come with the obligation of maintaining international financial stability.
Global capital flows, especially of the financial variety, on balance, are more short-term and add little to economic welfare when they enter emerging nations but cause damage when they leave. Hence, emerging economies need all the policy space they can get to deal with them. In the name of free trade in services and financial liberalisation, the US should not try to rob sovereigns of their policy space. The US should come good on the promise made in the April 2009 meeting of the G-20 to reform the governance of international financial institutions.
If it refuses to as much as acknowledge these issues, let alone act on them, then the world will find a way to conduct the bulk of its transactions in another currency.
(Based on remarks presented in the session on Trade and Investment at the Takshashila-Hudson Conference held in Bangalore on 2 August)
This piece was first published in Mint on August 11, 2014
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