Economic View: Let's keep America growing

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Are the signs of protectionism in the US business as usual or something more troubling? America has long had a strong protectionist tendency, which burst out most disastrously in 1933 with the Hawley-Smoot Tariff Act of 1930 that helped turn the US recession into a worldwide depression. This underlying instinct recurs periodically in import curbs, most recently over European steel and Chinese bras.

The steel barriers have been lifted and the bra quotas will presumably not be allowed to sour relations with China too badly. But now the North American Free Trade Agreement (Nafta), the deal with Canada and Mexico that has helped drive the surge in US growth over most of the past decade, is under attack. John Edwards, the challenger to John Kerry as Democratic nominee for President, is gaining support for his anti-trade agreement stance.

"When it comes to bad trade agreements, I know what they do to people," Mr Edwards said in a speech at Columbia University on Thursday. "I have seen it with my own eyes what happens when the mill shuts down."

Now you could say that Mr Kerry, not Mr Edwards, will be the nominee because that is what the Democratic establishment seems to have decided. In practical terms, the possibility of unravelling Nafta is nowhere near - it is about as likely as Britain having withdrawn from the EEC in 1983, when the Labour Party fought an election on that policy. You could also say that present claims about foreign workers stealing US jobs are age-old ones and that loss of jobs abroad has not stopped the US economy from being the most successful in the world.

All that is true. But there are still several new elements to the American trade debate, which taken together are profoundly troubling. One is that service jobs, as well as manufacturing ones, are now being moved offshore. Therefore, a new group of people is being affected, the white-collar middle class, whereas previously it was mainly factory workers who lost their jobs.

A second element is the US-China trade relationship. China has been the greatest beneficiary of foreign direct investment from the US, while US firms have been the greatest beneficiaries of cheap production facilities in China. But the result has been a huge trade deficit with China, which has in turn led to pressure from the US for a revaluation of the Chinese yuan.

This matters because the world has been relying on a combination of China and the US to drive the world economy forward for the past decade. The first graph shows how the joint contribution of that pair has outstripped the eurozone and Japan combined every single year since 1995. At present more than half of the total world growth comes from here.

Then there is a third element, the dollar. Arguably, the fall of the currency has started to do the job of correcting the big US trade deficit and will eventually help protect American jobs. That is what happened in the 1980s, when the dollar similarly soared and the trade deficit with Japan followed suit. The trouble with this argument is that the dollar may have to fall a lot further before the trade pressures are brought under control, and this is going to damage not only the eurozone but ultimately the US itself.

Thus US industry has started to recover - witness the rise in capacity utilisation of its factories (see next graph). But there is a long way to go before it is back to the healthy levels of the mid 1990s. Meanwhile, the US has relied on cheap imports to hold down inflation. Inflation in goods has virtually disappeared while that in services has also come right down (third graph).

Just as exporting manufacturing jobs to China has helped slow down inflation in goods, so exporting service industry jobs to India is holding down inflation in services. But were the dollar's fall to go too far, you would expect US inflation to start to climb. It has not happened yet but it is reasonable to worry.

There seem to be three important conclusions from this. The first is that the world needs the US to continue growing reasonably briskly and remaining an open market for the goods and services the rest of us produce. (Always remember that the States is Britain's biggest export market for goods and by far our biggest for services.)

The second is that while the US does benefit from cheap imports, the benefits are widely spread and not always apparent. This is always the political problem with free trade: you can see the job losses but you don't notice the few dollars off the price of a pair of trainers. My instinct is that the extreme pressure on US companies in this cycle has forced a sharper transition from domestic production to foreign production than in previous cycles, hence the so-called "jobless recovery". This is politically very difficult.

And the third conclusion is that it is in the self-interest of the rest of us to try to help. There is nothing that Europe can do about a loss of jobs to China and India, but there is something it can do to boost its own economies. Japan, at last, is growing well. The UK is growing well. But growth in the eurozone has been pretty disastrous.

As a region it is big - big enough to be a credible locomotive for the world economy. Exports have not been too bad, despite the strong euro. The problem is consumer demand. So the greatest contribution Europe could make to combat US protectionism is to get its people to spend more money. Sounds like win-win.