Why US and Australia are rethinking free-market economics amid China tensions
It was a neat apercu for the rosy economic orthodoxy that prevailed in the final years of the 20th century as the world celebrated the End of History. Now the free market, and what economists call “comparative advantage”, would decide which nations produced what as trade barriers fell. It shouldn’t matter where chips of either variety were made as long as GDP was increasing.
Thirty years later, Boskin’s comment looks rather silly. It turns out there was a massive difference: sophisticated manufactured goods that require a highly skilled workforce – especially those with potential military applications – confer economic and military might on the host nation.
That’s why the US government is frantically, if so far unsuccessfully, trying to stimulate more advanced semiconductor production on home soil.
The new rare earths deal inked by Australia and the US in Washington this week, which commits the two governments to invest billions in projects to mine and process these minerals that are critical to a wide range of industrial and defence applications, is yet another example.
It comes amid the escalating US-China trade war, which is supercharging an economic philosophy rethink in the US.
“Adam Smith may have won the battle of ideas, but his record is rather more mixed in the war for the minds of policymakers,” Harvard economist Dani Rodrik points out in his new research paper, What the Mercantilists Got Right.
Donald Trump’s fetish for trade surpluses and his implicit elevation of production over consumption have been treated with contempt by policy elites, as his administration pursues an aggressive mercantilist program.
But they far better reflect how successful nations have behaved, at least in the cases of Japan, China, Korea and Singapore. These countries have enjoyed the most rapid economic growth in human history largely through avoiding free trade.
“In view of China’s phenomenal rise in recent decades, some might even claim we are now living in a world that is increasingly the product of mercantilism, yet again,” writes Rodrik.
Asian nations have been more pragmatic in their economic policies, seeing the genius of Smith’s invisible hand as a tool rather than a religious edict – and one that works best domestically rather than internationally, where nations still compete. As China’s most reforming leader, Deng Xiaoping, once put it: “It doesn’t matter if a cat is black or white, if it catches mice it’s a good cat.”
Rare earths are not remotely rare, but China wisely invested in their production and processing, ultimately giving it a whip hand in global trade negotiations. In fact, most countries have them, but they are expensive to extract. Knee-jerk free-trade dogmatism might have blinded us to the value of earlier economic insights.
Everyone came down on Liberal MP Andrew Hastie like a ton of bricks recently for lamenting Australia’s loss of a car manufacturing sector. However unlikely its return, it is nonetheless worrying that Australia’s manufacturing sector is now proportionately the smallest in the OECD as a share of GDP, at just 5 per cent.
Ridiculously high energy costs, courtesy of the government’s obsession with replacing reliable energy with intermittent power, are mostly responsible.
But could Australia ever have become part of the world’s semiconductor supply chains had Canberra realised the emerging importance of the sector in the 1970s? Tiny Taiwan did it through massive STEM investment, and it has paid off.
It is no longer fashionable to argue manufacturing is special, but even Adam Smith once argued manufacturing, along with mining and agriculture, were the ultimate sources of wealth, because they are physical products of enduring value.
“(By contrast) the labour of … the sovereign … the whole army and navy, churchmen, lawyers, physicians, men of letters of every kind; players, buffoons, musicians, opera singers, opera dancers, etc, are all unproductive labourers,” he wrote.
In other words, Smith would have been aghast at the modern-day fawning over our booming publicly funded “care economy”, which some politicians appear to ludicrously believe is equivalent to our mining and energy export sectors. At least the NDIS employs people in Australia. Federal and state governments are now subsidising electric vehicles made in China at rates per car much greater than they ever provided to Holden, Ford and Toyota.
It’s a tribute to Australian farmers that they have thrived with relatively little support, but all of the world’s major nations still shovel hundreds of billions of dollars a year in subsidies to their farmers.
It’s almost as if the quaint ideas of Smith’s French contemporaries, the Physiocrats – who saw agriculture as the sole source of wealth – still resonate with the instinct to protect farming, even if they, like Smith, would never have endorsed subsidies.
Gold offers another stark lesson. As it rockets past $US4000 ($6150) an ounce, recall that Australia and Britain smugly sold off their official gold reserves for a few hundred dollars a generation ago, betting on the triumph of fiat currencies. That’s looking a less certain bet today, as China and Russia amass gold at record rates.
Like semiconductors or rare earths, gold was dismissed as just another commodity, with many ignoring its strategic role as a hedge against currency crises or a tool in global power plays.
None of this is to deny the remarkable power of the free market to supercharge living standards over time, not to mention the political freedoms they tend to promote. But a more pragmatic approach to trade might have put the US and its allies in a better position as they face off against China.
As Rodrik concluded: “Market competition and the division of labour are powerful engines of prosperity. But unleashing them often requires unorthodox policies and the guidance of the state.”
As in most areas of life, it’s better to behave in response to the world as it is, rather than as it should be. Even Smith noted exceptions to what became free trade – “defence is of much more importance than opulence”.
Adam Creighton is chief economist at the Institute of Public Affairs.
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“Potato chips, computer chips – what’s the difference?” Stanford economist Michael Boskin quipped in the early 1990s when serving as chair of George Bush senior’s Council of Economic Advisers.