Will more drinks cure a hangover?

Getting a just-right “Goldilocks” balance between imminent “bust” and (another) “boom” is really hard for a benevolent dictator. It’s near-impossible for individual democratic governments with short election cycles.

But it’s worse. We have an increasingly globalised world. We all depend (increasingly) on each other. Each country’s actions affect other countries (e.g., through international trade and capital flows). A synchronised global economic downturn requires a synchronised, mutually reinforcing, national policy response.

Here we face a real test. Each national government faces strong political/short term employment pressures to try to insulate its electorate from the immediate adverse effects of the global financial and economic correction (a.k.a. crisis). But doing so means cutting the trade and capital flow linkages between nations that have been important in supporting growth in the past.

History is a guide, if we are prepared to learn its lessons. Part of the reason for the extent and severity of the Great Depression in the 1930s was national governments “pulling down the shutters” on international trade via protectionist measures. This was motivated by a desire to keep local demand allocated to their own national production and jobs, and to insulate their respective economies from the economic turmoil in other countries.

Because this was a widespread practice, it was mutually self-defeating. Sure, each country’s imports were reduced. But so were each country’s exports (after all, one country’s imports are another’s exports). Globally, then, national governments made the situation worse by stomping on trade.

Despite this very clear historical lesson, never under-estimate individual national government incentives to cheat, and hope that they can get away with it.

Today, we hear all the right-sounding platitudes via communiqués emanating from the G7, the G20 and all sorts of groups (and individual government leaders). They all decry protectionist measures. But don’t listen to what national governments say. Look closely at what they are doing. Signs of protectionism are on the rise all around the world. Governments, seeking to maximise the local demand benefits of their spending initiatives, are engaging in all sorts of protectionist measures even as they loudly proclaim their opposition to them. Union movements, ostensibly the champions of workers around the world, can be no less ruthless in cutting off their poorer brethren overseas in an attempt to protect their own locally (via “buy Australia”, and “fair trade not free trade” campaigns, and the like.)

Amplified and multiplied across a myriad of government procurement and policy areas, this trend will definitely make the looming global economic downturn much worse. It’s already happening.

What shouldn’t governments do? They shouldn’t be hypocrites, denouncing protectionism in words while embracing it in deeds. I’ll bet most if not all are guilty. Australia is, too. You don’t need to dig far to establish that. Governments can even exploit loopholes in the way the World Trade Organisation operates (just ask the Europeans). Memo WTO head, Pascal Lamy: do you sleep well at night?

In short, on protectionism, governments “talk the talk”. On action, they should U-turn, and “walk the walk”.

What role can central banks, (e.g., the Reserve Bank of Australia) play? Lower interest rates can be powerful tools, reducing debt-servicing costs, facilitating faster “de-leveraging”, and lowering hurdle rates of return for new investments. (Their additional role in lowering a country’s exchange rate is likely to be limited when all countries are reducing interest rates.)

Central banks must keep a longer-term eye on inflation, however.