Financial Regulation and Commercial Protection: Should Policy Change?
Barrell, Ray, Weale, Martin, National Institute Economic Review
When protection is discussed people normally have policies designed to restrict imports in mind. But the way in which the international economy has been affected by toxic financial assets issued in the United States suggests that countries might face problems not only because of the goods and services trade but also because of the financial assets they import. Thus, in discussing the case for protection, we consider first whether there is a case for protection to prevent economies importing some types of financial instrument and, secondly, whether there is a case for more traditional protection as a way of resolving the global imbalances of the world economy. We conclude that financial protection is a sensible way for countries to protect themselves from risky assets if the production and testing of such assets is not regulated internationally.
The situation with respect to import restriction or commercial protection is rather different. There is likely to be increasing pressure for the United States to adopt protective measures to restrict imports from China; however, plausible protective measures are unlikely to have a sharp impact on global imbalances and will damage welfare in the United States. One form of protection which the United States could implement, restricting imports of oil by means of taxes on fuel use, has the potential to reduce global imbalances sharply, and also helps to achieve global carbon emission targets, but is not very likely to be introduced.
We begin by reviewing the issues surrounding financial protection and then proceed to consider the question of restrictions on imports.
The financial counterpart of controls on the international movements of goods and services is controls on the flow of capital. No one expects to go back to the Bretton Woods world, where fixed exchange rates were sustainable only if there was a shared commitment to a common inflation rate with the system supported by means of exchange controls and a parallel market in investment dollars.
Capital controls prevent markets working in the large as well as the small. There are two main functions of international capital markets, with the large and important one involving the redistribution of savings from surplus countries to deficit countries, and the small one involving asset swapping in order that risks are shared efficiently.
Long-term structural surpluses and deficits exist for many sustainable reasons, as well as for some unsustainable ones. Countries with populations that are older, or ageing more rapidly than others, may need to save more as a per cent of income, and if capital markets work well they will run current account surpluses. If they do not, the excess saving will be absorbed by increased capital at home, and the marginal return on capital in the potential surplus country, for instance Japan, will be below that in the potential deficit country. Equalising returns increases global output for a given level of the capital stock. The same may happen between two countries with different habits over working time. If one country, say the US, has institutions that induce its citizens to work seven years longer than those in another region, say the Euro Area (as is currently the case), then there are structural reasons for US deficits and European surpluses. US citizens need more capital to work with than do Europeans, as they input more labour, but they will want lower levels of financial wealth as a proportion of their incomes as they need to save less for retirement. The reverse is true of the Europeans, and they will own US assets in order to provide incomes for their longer retirements. Hence, if they have the same technology and skills, then in a growing world there are good structural reasons for permanent net capital flows from Europe to the US that will increase global output.
The risk sharing function of international capital markets has nothing to do with structural deficits and surpluses, but it does have a great deal to do with the recent financial crisis. …