After the Cold War, the United States and Europe established an economic system based on open markets, global trade, and limited government intervention in the economy. Climate change The danger was distant. Allowing countries such as China or Russia into the global economy was widely seen as beneficial to both them and their Western trading partners. As both countries develop, they will surely adopt market economics and eventually democracy. Other things mattered. But economic considerations took priority.
not anymore. Policy makers on both sides of the Atlantic have come to the conclusion that national security and climate change must now come first. In Brussels there is talk of “economic security” and “strategic autonomy” – policy makers want the bloc to be able to chart its own course. European Commission President Ursula von der Leyen recently said she wanted to “de-risk” relations with China. Officials in Washington have similar ambitions. He believes that the old world order allowed America’s industrial base to erode, leading to economic dependence. It has been used for geopolitical advantage, the climate crisis has been ignored and inequality has been amplified in a way that undermines democracy. Yet pursuing greater security, tackling climate change, and trying to counter the threat of China involve all kinds of trade-offs. Even though economic thought is no longer dominant, the discipline of economics still has much to offer.
For example, to use economic weapons like sanctions wisely, national-security types must accurately estimate their costs. Russia’s invasion of Ukraine the previous year provided a test case. At the time, a debate broke out in the European Union on whether to ban Russian gas imports. The fear – expressed strongly by businesses and industrial associations – was that the sanctions would deal a brutal economic blow, not to Russia, but to Europe. When a group of economists, including Ben Moll at the London School of Economics and Moritz Schulrich at the University of Bonn, analyzed the potential impact At the time, he predicted a harder, if less severe, hit from such measures, as he expected the economy to rapidly adjust to the shock. And the EU escaped recession, even though gas consumption in the 12 months to February was down 15% from a year earlier. In a new paper, three economists from the group that provided the initial forecast argue that Europe could face immediate gas curbs in April 2022 rather than cuts later in the summer. A forthcoming paper by Lionel Fontaine and others at the Paris School of Economics, which studies energy-price shocks in France over the past few decades, comes to a similar conclusion: firms adapt rapidly, and employ only partially. And by cutting production.
What about an economic conflict between the West and a larger, more powerful rival like China? Using the same model as the group above – and only paying attention to intermediate inputs, eg semiconductor Or engine parts instead of finished products – European Central Bank researchers divide the world into two factions: “East” and “West”. If the blocks were to return to the limited trading of the mid-1990s, analysis shows that the short-term hit, before Global Economy Adjusted at around 5% of global GDP, that would be huge. But over time the loss will come down to about 1%. The impact on the US and China will be relatively small compared to globally integrated economies such as the euro area. Small open economies like South Korea will have to bear the brunt of this.
An interesting aspect of the East–West confrontation is technological diffusion, which is an important component in economic development. Less trade means less learning opportunities, especially for poor countries. Carlos Goes of the University of California, San Diego and Eddy Bakers of the WTO are looking at the impact on such dissemination of the breakdown of relations. They find that the consequences for the US economy as the technology leader are again manageable. The impact on China or India would be substantial, as both countries would miss out on opportunities to grow.
Compromise can be more painful when it comes to climate change. President Joe Biden has set aside more than $1 trillion for green incentives and manufacturing over the next decade. There have already been high-profile investments by large companies. But these could also be schemes that have been put forward to secure subsidies. Meanwhile, the evidence on interventions to boost industrial employment is decidedly mixed. Chiara Criscuolo of the OECD and others have analyzed past EU efforts. They found that the bloc’s plans supported employment, but only in small firms. Big companies take payment without adding jobs.
Other countries are responding with green subsidies of their own, and more are likely to be added – which may be unwise. The world needs every bit of economic efficiency to maintain a stable climate, as resources are limited Government budgets have become increasingly strained, In a new working paper, Kathleen Schubert of the Paris School of Economics and others look at different combinations of carbon taxes and green subsidies. They find, in line with earlier research, that relying on subsidies to green an economy comes with a larger cost than a carbon price.
danger of consensus
Danny Roderick of Harvard University, a critic of the old “Washington” consensus, is very welcoming of the new era. But in a recent essay on industrial policy, he describes how difficult it is to get such interventions right, and warns that trying to achieve multiple goals (say, combating climate change) with a single lever handling, promoting industry and increasing safety) increase the likelihood of failure. Furthermore, any paradigm that becomes conventional wisdom is in danger of promoting one-size-fits-all solutions, writes Mr. Roderick. In the eyes of its critics, the old Washington Consensus falls short when it comes to fairness and development. Now it is easy for economists of all kinds to see the dangers of the new consensus. Policy makers would be wise to listen.
Read more from Free Exchange, our column on economics:
How Japanese policymakers fell into a very deep hole (May 4)
Economists and investors should pay less attention to consumers (27 April)
Is China better than the US at monetary policy? (20 April)
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