Watch Your Wallets, Protectionism is Back!

Protectionism is on the rise all over the world, thanks or should we say “no thanks” to the global economic crisis.  Last November, G-20 leaders pledged to fight protectionism. Yet, according to the World Trade Organization (WTO), 18 out of these 20 economies have since taken measures to restrict trade. With the global economy struggling to recover, political pressures demanding protection from import competition to sustain domestic employment are intensifying. It is likely to prove right the old adage that the only thing we learn from history is that we never learn from history.  One lesson from the experience of the 1930s that is currently most relevant is that raising trade barriers deepens and prolongs recession.

There is no shortage of creativity when it comes to protectionist measures. Since November, 2008, several countries have implemented a variety of measures which on the surface do not appear to be restrictions on trade but in effect restrict trade at the expense of other countries. One example is Argentina’s imposition of non-automatic licensing requirements on auto parts, textiles, TVs, toys, shoes, and leather goods. Another one is Indonesia’s requirement that five categories of goods (including garments, footwear, toys, electronics, food and beverages) would be permitted in only five ports and airports. Other countries have tightened standards to slow import entry, including, for example, India’s ban on Chinese toys and China’s import ban on Irish pork as well as rejection of some Belgian chocolate, Italian brandy, British sauce, Dutch eggs and Spanish dairy products.

These do not include antidumping measures.  The number of antidumping initiations surged in 2008 after a period of slowdown.  Developing countries accounted for the majority of initiations, though developed countries accounted for the greatest number of duty impositions. India was the most active, accounting for 29 percent of total initiations. The US and EU imposed duties most frequently. 

In a global recession, each country wants to boost demand for the goods it produces, which leads to a “prisoners’ dilemma”.  Policies which divert demand to domestically-produced goods are rational from a national point of view, but irrational from the global perspective when all countries do the same. Such policies are obviously a losing proposition, but no one country would benefit by refraining from it when others are not.  Hence trade protection is a textbook example of countries attempting to prosper at the expense of others. .

It is indeed possible that these policies are not just globally irrational, but nationally irrational as well. An increase in domestic demand due to increased protection is likely to put upward pressure on interest rates. An increase in domestic interest rates stimulates capital inflow, leading to currency appreciation if the exchange rate is flexible. This makes exports more expensive and imports cheaper.  Consequently, exports fall and imports rise. The resulting fall in net exports offsets the initial expansion in domestic demand.  Thus, part or all of the increased demand from higher protection leaks out to foreign countries. Most countries, by the way, have flexible exchange rates. 

The impact of the protectionist measures so far is probably small. The sharp contractions in trade volumes since the onset of the global crisis resulted not from protection, but from the global recession and from the rapidly rising costs of an emaciated pool of trade finance. Nonetheless, the trend in protection is a big concern.

Fortunately, unlike the 1930s, countries at present are far more interdependent through supply chains and imported inputs. Production chains link global markets through a network of trade in parts, components and even services.  Also, export interests are far more powerful. Rounds of agreements under GATT/WTO have provided much greater institutional stability of trading relations.  The changed political economy has helped circumvent some egregious restrictions such as the “Buy America” provision in the US stimulus package.

A key lesson from this experience is that progress on trade liberalization is never safe from the piracy of special interests.