Keynes at Home, Smith Abroad—the Right Approach?

Originally published by the Carnegie Endowment for International Peace
Participants: Sanoussi Bilal, Uri Dadush, Fredrik Erixon, Simon O’Connor

Leading economists have described the 2007-2009 economic crisis as the worst since the Great Depression. As consumption rates drop, jobs are lost, and investments diminish. Regulators worldwide are questioning the system that has driven the global economy for the past two decades.

While the World Trade Organization (WTO) has held its post as the guardian of stability and predictability in world trade for almost fifteen years, its involvement and influence in trade is now in decline. Increasingly, it is being bypassed by unilateral, bilateral, and regional processes. If it is to remain both effective and relevant, the WTO must be reformed to meet the diverse challenges facing it, especially the difficult balance between protectionism and free trade.

Sanoussi Bilal, head of the Programme on Economic and Trade Cooperation at the European Centre for Development Policy Management, Carnegie’s Uri Dadush, and Fredrik Erixon, director and co-founder of the European Centre for International Political Economy, discussed the current world trade situation and the challenges facing the WTO. Simon O’Connor, editor of E!Sharp, chaired the discussion.

Current Economic Situation

Erixon reviewed the global economic landscape, reflecting on the model that has dominated the global economy for the past sixty years, as well as the measures governments have adopted to deal with the current crisis.

• Embedded Liberalism: The post-Second World War economic system was founded on an economic model known as Embedded Liberalism, which is a combination of international economic liberalism, domestic Keynesian economics, and the development of the welfare state. This model worked admirably in the post-war era, and was responsible for much of the economic growth in Europe and America. As the global economy expanded to Asia, Latin America, and parts of Africa, the benefits of the system were also felt by millions of people that had previously been locked out of global trade.
• Mild Protectionism: During the current crisis, there has been an emergence of a mild wave of protectionism. However, the massive move towards protectionism that many feared did not take place.
• New Trade Measures: During the crisis there has been extensive use of new types of trade measures, including:
  • Non-tariff barriers, like the imposition of new standards and technical regulations.
  • Government subsidies to different sectors, particularly the automotive and banking sectors
  • Government procurement discrimination, used to favor domestic producers and discriminate against foreign competitors.

The WTO

Erixon stressed that there has been no significant challenge to the World Trade Organization or any other trade agreements during the crisis. On the contrary, he argued, the WTO and other organizations have disciplined the behavior of governments.

While governments have avoided adopting the protectionist measures regulated by World Trade Organization agreements, Erixon pointed out that they have made frequent recourse to those trade measures not covered by the World Trade Organization or other agreements. Measures like non-tariff barriers, subsidies and procurement discrimination are less confrontational and less overt, but nonetheless pose a fundamental challenge to the world trading system in the future.

Dadush explained that the WTO has failed to fulfill its promise as a source of new trade rules and liberalization. There needs to be official recognition that the WTO is not generating the results it should be and therefore that reform is necessary. He suggested that:

• The WTO should move away from the single undertaking and consensus rules, which oblige all member states to agree on every aspect of a program before it can be adopted and have made negotiations a daunting task. It should adopt an approach similar to the variable geometry approach of the European Union, whereby member states are not all obliged to abide by the same agreements, and specific issues on which a critical mass of members wants to go forward can be identified.
• The WTO needs to be more responsive to the needs of individual countries and groups of countries, including regional arrangements. It should recognize that these arrangements are a significant force and work with them in a constructive way.
• It is vital to connect the WTO to the trade reforms that are already happening within countries. The reform process, he concluded, is urgent and cannot wait until such a time as the Doha negotiations are concluded.

The Long Term Consequences

There has been a fundamental change in the way we look at economic policies and debates, Bilal argued. The accepted economic wisdom of the past decades has been brought under intense scrutiny by the economic crisis and it is no longer taken for granted that deregulation and small government are the best policies.

Governments and economists are now advocating the importance of aggressive fiscal policies and stimulus packages, and a clear role for government in the economy and economic regulation is emerging. However, he stressed, governments are still lukewarm in their acceptance of this Keynesian approach and their focus so far has been on rescuing the financial sector.

Erixon agreed that a change has occurred. The economic model that allowed for the welfare state at home and liberalism abroad is deteriorating. There is a growing conflict between what governments do at home and what they do abroad, one which is difficult to address in any sort of international agreement. The future of the global economic order will depend less on the reform of existing institutions and more on the ability of key members of the global economic order to reform the political structures that today are impeding the drive to expand global trade.

The global economic crisis, Bilal argued, has ultimately been a failed opportunity to engage in significant, medium and long-term reforms. So far the changes that have been made have been largely cosmetic ones, aimed at maintaining the status quo. If this does not change, he concluded, then the problems that led to the current economic crisis will occur again.