Beware protectionism

Speaking at the India Investment Forum in New York,Finance Minister Pranab Mukherjee warned the US against resorting to protectionism. What he likely had in mind specifically in the context of the bilateral relationship were US restrictions on H1B visas and the persistent political tirade against outsourcing. Unfortunately,the ugly head of protectionism is rising globally at precisely the moment when the global economy needs it the least. There are,of course,reasons for this. The post-crisis economic recovery in many parts of the world,but particularly in the advanced economies,has been painfully slow; unemployment rates are high. The temptation for politicians to lurch to damaging populism,against free trade,is therefore quite high.

More worrying than careless rhetoric is the potential outbreak of a real currency war,where countries try to outdo each other in undervaluing their currencies to give a boost to exports and growth. China is the root of this problem,insisting on a rigid,undervalued peg to the US dollar. This gives it an unfair advantage over other exporting countries: countries like Thailand and Colombia have already responded by devaluing their currencies. The advanced economies are also tempted to respond in kind. The US has been trying to push the dollar down by keeping interest rates close to zero. In the midst of this damaging race to the bottom,countries like Brazil and India,which have,so far,not resorted to blatant currency manipulation,are likely to take a hit on the export front. Over the medium term,if everyone joins the budding currency war,all the world will get is higher inflation and no real gains on either exports or growth for any single country.

This is going to be a test for international policy coordination at the next G-20 summit in South Korea,and could well determine the credibility of this institution. After the euphoria over coordinated stimulus in late 2008,international coordination has been rather disjointed. Even the long-promised reform of IMF voting structures,something the finance minister flagged in New York on Thursday,has remained a promise unfulfilled.