Summary
The Potsdam meetings confirmed what analysts already know -- concentrating on solving the problem of "agriculture" will forever doom global trade talks and lead to an impass that will surely force changes in the underlying views of the Atlantic concensus that "free trade" is always preferable to "managed trade."
Analysis
The collapse of the Potsdam trade talks between the United States, the European Union, Brazil and India suggests that the Doha agenda is dead. Honestly there's no risk to the world economy from that outcome.
The Doha Round is in trouble. As always in trade talks, it is the thorny problem of agricultural protection that makes finding a solution difficult. For more than two years the negotiations have been held up by the question of the size of European (and to a lesser extent) American agricultural protection. The discussion centers on cutting tariffs in the European Union by trimming subsidies given to farmers through the maintenance of price floors for farm products (sometimes more than twice those apparent in world markets). Direct subsidies alone—in the form of grants to farmers and subsidies for exports – are estimated to cost the EU more than $ 92 billions a year. The EU has proposed a gradual reduction in implicit tariffs imposed on foreign imports of about 25%. The G20 group, made up of rich and poor countries alike, demands reductions of over 50%. Even the 25% gradual decline would likely be unacceptable to at least some countries.
What is curious about this emphasis on agricultural trade is that it benefits only a few countries in a few products. It could, however, do significant damage to the worlds already fragile food supply and safety net. My estimates are that demand will outstrip supply without removing a significant producing area from production. Europe collectively accounts for 27% of world production of agricultural products, and it consumes about 28% of world output. It buys about 39% of world traded agricultural products and sells about 36% for a net trade deficit of about 3%. If European producers were willing to work for peasant wages, then most of this European farmland would remain in production. But it won’t!
Imagine that Europe, as a result of the elimination of protection given to farmers, takes out of production just some marginal land, say 15% of total land, reducing world supply immediately by 4%. The price elasticity of wheat, corn, and soybeans for most European countries is around .25. For every 1% reduction in world market supply we expect prices to increase by 4%. If our calculations are correct by about 16%. Some marginal land could return to production, but it is unlikely. The world already strains to produce enough food today, the problems multiply as incomes rise in Asia and population continues to grow in many poor countries.
The optimists believe that other producers would make-up for the loss in European production. But this could only happen if there were changes in climate and patterns of rainfall. The more reasonable scenario is that increasing desertification and limits on water will make it harder to grow crops in many other major producing areas. Europe is one of the few places that this shift is not taking place. Australia, the United States, Canada, and Argentina, all major grain producers, are prone to periodic droughts that cut food production.
Developing countries, who have viewed this “opening” of European and American markets as beneficial, will likely find the impact of a decline in European production devastating. The higher prices will have a significant impact on the majority of the developing countries since most are net importers of food grains and oil seeds. And, in times of famine, the surpluses that have sustained life in many parts of the world will be missing. The UN World Food Program will be without resources to meet these emergency needs.
The unintended consequences when you start to play with fundamental social relationships sometimes overwhelm best intentions of theorists and dreamers. For example, surplus Brazilian sugar cane is now being processed into ethanol replacing imported petroleum. Higher prices for sugar cane as it replaces European sugar beets in European consumption would drive prices higher and make ethanol production uneconomic.
Agricultural production is basic to all economies. The first social compact was made between farmers and hunters allowing the development of permanent settlements and specialization. It would be better if the Doha Round concentrated on examining how trade can be harnessed to improve the lot of workers (wages, working conditions, and respect for the environment). This would do far more to insure long-term growth and stability than this myopic concentration on opening up markets to the free flow of agricultural products.
International trade policy is not normally discussed in an election contest. Most politicians are simply ciphers for, as Keynes neatly put it, “dead economists”. They mouth the world “ free trade” leaving the hoary details of a $ 800 billion trade deficit to the markets to solve. As The Economist ( September 11th, 2004) reported (and as my own trade models confirm) the current deficit if left to the market will reach about $ 1 trillion by 2010.
Fred Bergsten of the International Economic Institute in that same issue of The Economist sounds the alarm about the perils of the world economy collapsing in chaos unless something is done about the deficits, the high oil prices, and the growing imbalance in global trade. On the one hand he suggests that we are moving towards a crisis caused, in part by the growing double whammy of a half trillion dollar trade deficit and a Federal government deficit of equal size, and on the other he worries about the trend in American politics towards international protection.
Bergsten is now recognizing the problem caused when US imports are almost twice exports. Yet he offers no solutions that will slow this hemorrhaging of lifeblood (in this case, American manufacturing skills). Bergsten places his full faith in the ability of price alone to reverse this trend. He assumes that a 20% increase in the Chinese Yuan might solve this dilemma. Even a 20% revaluation would not stem the flow of low cost Chinese manufactures to the US and Western Europe. Chinese wages are unlikely to rise significantly as there is a huge and growing surplus of labor waiting to find work. A revaluation of the currency would; however, help Chinese companies by allowing cheaper imports of basic raw materials, primary metals, and other goods in short supply thus adding to global inflationary pressures.
We need fundamental changes in our underlying faith in the power of the invisible hand and free markets to solve problems of scarcity and to ration supplies of food, shelter, energy, and raw materials. Globalization may not be the panacea for what ails the global economy. New ideas are needed that cut to the heart of the current dilemma. These include the following concepts:
- Global Balance -- The goal of a free trade system is to achieve equality of gain and loss from international exchange – Countries with a chronic trade balance should be allowed to demand that either the trade imbalance be eliminated through increased access to the markets of trading partners or that will take actions to reduce and/or eliminate the trade imbalance without penalty or negative consequences.
- The Cost of Scarcity and the Importance of Maintaining Endangered Supplies – While the short-term problem of over capacity existed prior to explosive growth of both China and to a lesser extent India, models show that demand will largely outstrip available supply in the future. As wealth multiplies faster than available supply, price inflation is more likely than deflation. The thirty year effort of major agricultural countries to batter down protectionist barriers in agriculture are thus short sighted. Imagine what the price of wheat, corn, or soybeans would be if all the European production, equal today to meeting the needs of more than 300 million high income Europeans, were to disappear as protection of home market producers is withdrawn.
- Limits to Growth and Development – There may be limits imposed by the ability of the planet to meet all needs equally. Markets alone will not deal with these problems or solve issues related to externalities that come from rapid development (China’s rivers are already running black and pollution choke it’s overcrowded cities.) Extending global industry and trade models beyond 2010 is frightening. Assuming continued development proceeds, slowing as countries become more developed from higher rates earlier, the demand for primary food products will be 3 times that of 2003 and for energy and raw materials demand will be up 5.6 times current levels. Meeting these demands, without self destructing prior to achieving full scale development, will require more than paying lip service long dead economic theories of the efficiency of free markets alone to solve all problems of distribution.
