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The sale of the Crafar farms exposes the fault line in the world economy, writes Peter Lyons. The Chinese approach to international trade contains the seeds for its own demise.
I am opposed to the sale of the Crafar farms to Chinese interests on purely economic grounds. This is not to say that I favour a lower bid by New Zealand interests. I would like to share my reasoning because it underlies the economic malaise that most Western economies are experiencing.
New Zealand has embraced the concept of free trade in recent decades. As a relatively insignificant country on international markets, that relies on exports, a world with no artificial trade barriers would suit our interests.
Unfortunately, like world peace and the elimination of global poverty the attainment of free trade flounders on political realities. While New Zealand has pursued the chimera of free trade , China has adopted a trade policy called mercantilism. To understand what this means for the world economy it is necessary to explore a bit of the history behind global trade.
Adam Smith is regarded as the father of modern economics. He wrote An Inquiry into the Nature and Causes of the Wealth of Nations in 1776. His book was an attack on mercantilism, which was the ideology that dominated world trade at that stage in history. The rulers of countries sought to use trade to maximise their holdings of precious specie such as gold and silver.
This made sense for absolute monarchs who used these precious metals to fund their military adventures. They used restriction on imports such as tariffs for revenue and to reduce imports to prevent an outflow of precious metals.
Smith pointed out that such an approach to international trade was self-defeating. If all countries sought to export more and import less, international trade would wither. He emphasised that the benefit of international trade was it allowed countries to specialise in what they were most efficient at producing and import other items. All countries could benefit through specialisation and increased trade, output and consumption.
By the mid-19th century Smith's ideas had been adopted by the British, who were the dominant world power. Free trade suited their interests as the dominant world manufacturer. They needed access to markets for their output and for raw materials. They also had the naval power to enforce this policy.
During the Great Depression of the 1930s, many countries introduced trade barriers to restrict imports and bolster local businesses and employment. It is now acknowledged that these policies increased the depth and severity of the Depression.
In 1944 the victorious allied powers met at Bretton Woods in the United States to establish an international economic framework to prevent another Great Depression. This meeting initiated moves to reduce trade barriers, culminating in the establishment of the World Trade Organisation in 1995.
The problem is that China in particular is playing the mercantile game when it comes to world trade. Its sheer size means this has a massive destabilising effect on the world economy.
Over the past decade, China has deliberately kept its exchange rate low to give its exports a competitive advantage. This has flooded world markets with cheap manufactured goods.
The flood of cheap imports helped keep inflation down in many countries, allowing central banks to keep interest rates lower than they would otherwise have been. This encouraged consumer borrowing and spending.
More importantly, the massive trade surpluses of China, and other surplus nations such as oil-rich Middle Eastern countries, were lent back to their customers. This led to a flood of easy credit in most Western economies during much of the first decade of the new millennium.
This easy credit created a housing bubble throughout the Western world, including New Zealand. This led to a feel-good effect that caused homeowners to borrow and spend more. This fuelled an illusory boom that came to an abrupt end in 2007-8.
In countries such as Ireland and Spain the private debt that this process created quickly became government debt as governments were forced to bail out their banking systems.
More insidiously, the Chinese trade surpluses have been used to buy up the resources and productive assets of other countries. The bid for the Crafar farms is part of this process.
This advantage of mercantilism was less obvious during Smith's day, otherwise he may have been hesitant to criticise the long-term strategic benefits of mercantilism.
Unfortunately, the Chinese approach to international trade contains the seeds for its own demise. If your customers are mired in recession and up to their eyeballs in debt then you are unlikely to be able to continue to sell to them. This creates a major problem for the Chinese authorities, who are reliant on export-led growth. We are almost at this stage at the moment.
The Chinese economy is now the second largest in the world. If the Chinese were to allow their currency to appreciate, it would increase the total purchasing power of Chinese consumers. This massive surge in world demand would help kick-start the world economy.
I am opposed to the sale of the Crafar farms to Chinese interests because when it comes to international trade China is playing by different rules from us. If all countries adopted China's approach to international trade the world would be much poorer. It is a "beggar-thy-neighbour" strategy.
Countries that support free trade need to point this out on the world stage and refuse to allow the Chinese to use their trade surpluses to buy their productive assets.
• Peter Lyons teaches economics at Saint Peter's College in Epsom and has written several economics texts.