Bonfire of the certainties
Erik Jones / May 2016
Mario Draghi, president of the European Central Bank, and Wolfgang Schäuble, the German federal minister of finance. Photo: European Union
Free trade is welfare enhancing. Interdependence requires cooperation. Central banks should be politically independent. And the United States is the indispensable world leader. These are the certainties we used to offer graduate students in international relations. Now they are all aflame.
Consider the fate of free trade. There have always been critics of trade liberalization for reasons related to competitiveness (infant industry), development (important substitution), market failure (environment), or exploitation (labor standards). Moreover, no-one ever doubted that free trade benefits some more than others. Nevertheless, the consensus that free trade is welfare enhancing has held. Large multilateral trade negotiations may have given way to smaller and less ambitious bilateral trade deals but the measure of progress has always been more rather than less.
Now that is changed. The problem is not the implicit failure of the Doha Round of trade and development talks within the World Trade Organization. It is the muted and halting success of the Trans-Pacific Partnership, the open controversy of the Trans-Atlantic Trade and Investment Partnership, and the fact that neither of the two leading candidates for the United States Presidency is openly supportive of free trade and one, Donald Trump, appears openly hostile. Worse, opposition to free trade has increased as trade negotiators (and their political masters) have tried ever harder to accommodate critics by bringing more voices and a wider array of issues into the debate.
The assumption underlying the critics of free trade is that national -- or, in the case of Europe, regional -- autonomy is better than international cooperation. The French want to insist on their own standards for sanitary and phytosanitary protection, the Germans want to use their legal system, the British want to restore the sovereignty of the parliament at Westminster, the left in America wants to protect wages and working standards and the right promises to fend off rapacious global predators. This assumption denies that cooperation is essential when economies are interdependent and insists that national policymakers can achieve national objectives acting alone.
That insistence on the effectiveness of autonomous national officials flies in the face of decades of research that shows how conflicting national policies are both inefficient and counterproductive. It also ignores the experience of Europe's internal market. Of course reasonable people can and should disagree on how best to regulate markets, resolve disputes, protect or compensate those who have to adjust to liberalization, and accommodate competing interests. But to shift from a cooperative framework -- no matter how controversial -- to a pattern of go-it-alone policymaking is hard to imagine. Nevertheless, that is where the political debate is headed across a range of issues in the Atlantic Community (to borrow the term Richard Cooper used in the subtitle for his classic work on the economics of interdependence).
The debate about central bank independence is even more surprising. Every introductory macroeconomics textbook includes an explanation of the time-inconsistency dilemma according to which monetary policymakers who respond to short-term political pressures wind up delivering worse performance in terms of both inflation and unemployment in the longer term.
Following the logic of this argument, politicians should insulate monetary policymakers from short-term pressures so that central banks can create the conditions for more stable prices and higher levels of employment over the longer-term. The treaty provisions for European Central Bank are a good illustration. Those provisions not only prohibit European monetary policymakers from accepting political direction, but they also enjoin European politicians from offering that direction in the first place.
The European treaties include strong provisions for central bank independence because the German government insisted on it. That same Germany is now challenging the European Central Bank’s conduct of monetary policy. German Finance Minister Wolfgang Schäuble even went so far as to suggest that the ECB’s monetary policies were driving German voters into the arms of the Alternative für Deutschland(AfD), which is a right-wing populist political party.
Assume for the moment that Schäuble is right and the monetary policies of the ECB have fueled the growth of German populism. That is not hard to imagine. The AfD started life as an anti-euro political movement after all. What matters is that this is precisely the kind of short-term political pressure that should not be allowed to influence the choices made by monetary policymakers. Whether economists outside the ECB agree with those choices is irrelevant because this is an argument about politics and not about economics. And for Schäuble to channel that pressure to the ECB runs precisely against the injunction written into European treaties.
Of course the irony is that this is not the first time that the German government has chosen to ignore a rule that Germany insisted be written into the treaties (and supporting legislation). The last time was with reference to the excessive deficits procedure and the Stability and Growth Pact. Schäuble has made it clear in successive interviews that he was in the opposition when that change of heart took place in November 2003. His explanation for this break with the economic consensus surrounding central bank independence is less convincing. That said, the challenge to central bank independence is obvious and Germany’s own top central banker, Jens Weidmann, is on the other side of the debate.
The point is not to cast stones. Rather it is to underscore that a world without free trade, multilateral cooperation, and central bank independence is a strange place. It is made all the stranger by the prospect that the United States will pivot from global leadership to an America-first kind of isolationism. If this transformation takes place, it hard to see who will push to restore the previous consensus on trade, cooperation, and monetary policy.
The old international system will be hard to recover and a new, more uncertain world will have to be built on its remains.