Protectionism is on the rise

Posted by Fredrik Erixon on 14 February 2009

Protectionism is on the rise. World leaders have pledged there will be no repeat of the 1930s, when tit-for-tat protectionism turned a recession caused by the Wall Street crash into a decade-long depression. But such pledges are hardly reassuring: it is a replay of the creeping protectionism of the 1970s that governments should be worried about, not the spiraling protectionism of the 1930s. If governments are true to their promises, they are preparing for the wrong battle.


Historical precedents

Protectionism in the 1930s was a series of tariff hikes that badly hit fragile trade patterns. But the world economy has changed since then, and so have the preferred tools of protectionists. The threat of out-of-control tariff hikes is no longer realistic; even the most bone-headed legislator understands that in a world of globalized supply chains, you will damage your home firms’ competitiveness if you trigger tariff escalation.

The lesson from the 1970s is different. A series of shocks and crises (such as the collapse of the gold standard and the oil-price hikes) marked the end of a long boom and triggered more government intervention. New labour-market and capital-market regulations were introduced. Subsidies were sprayed at ailing firms and vulnerable sectors. Escalating domestic interventions exacerbated an initial crisis, prolonged stagnation -- and spawned protectionism. Industry after industry, coddled by government subsidies at home, sought protection from foreign competition. The result was the “new protectionism” and “managed trade” of the 1970s and 1980s.

Policies like “voluntary export restraints,” “orderly marketing arrangements” and other mostly nontariff barriers followed hard on the heels of bailouts. The sectors that received subsidies at home also got protected from foreign competition. Through the 1980s, American car manufacturers were protected by Voluntary Export Restraints (VERs) that restricted the number of Japanese cars exported to the US Europe negotiated a similar agreement with Japan in 1983. To further restrict Japanese exports, some European governments imposed “local-content requirements” on the cars produced in Europe by companies like Nissan and Toyota. Many other sectors, like semiconductors and videocassette recorders, were also protected by VERs or similar measures. The French government even demanded that Japanese VCR imports enter France via Poitiers, a town hundreds of miles from the nearest port.

The parallels between then and now are stark. Governments around the world have again bailed out the automotive sector. The corporate welfare queens of the 1970s, such as Chrysler and Rolls Royce, have fallen back into welfare dependency. Rules in Europe governing state aid have been relaxed to allow for greater subsidies. In the United States, the new administration may press ahead with “Buy America” provisions attached to its fiscal stimulus package. Russia has already introduced such provisions. In countries as diverse as China and France, “strategic” sectors housing “national champions” have been sheltered from the embrace of foreign investors. Bailed-out companies and sectors have been instructed not to move production abroad or to employ foreign workers. Bailed-out banks have been told to lend at home, not abroad. And antidumping measures are increasing.


Creeping protectionism

This is creeping protectionism. It is not an upfront declaration of a trade war using tariffs as preferred weapons; rather it is protectionism with non-tariff weapons. This is not new; rather it emerged from the slowdown of global trade and investment liberalization in the decade before the onset of global financial crisis.

The United Nations Conference on Trade and Development has recorded an increase in new laws unfavourable to foreign investment. Since 2005, a quarter of all new investment laws have been considered unfavorable to foreign investment, compared with a much lower average (7.5%) from 1992 to 2004. These restrictions are primarily in energy sectors but are spreading. The Chinese government, for example, has tightened foreign-investment restrictions through a series of regulations and “guiding opinions.” These are intended to protect national champions in industrial, energy and services sectors.

“Green protectionism” poses yet another threat to global trade. The European Union already has an emission-trading scheme in operation, and the Obama administration has indicated that it would like the US Congress to pass a similar scheme in the next year. Because these schemes impose substantial costs on energy-intensive sectors at home, pressure is growing to impose similar costs on countries producing more cheaply and without such policies. Hence the chatter about “carbon tariffs”, which would be aimed primarily at big emerging economies – China in particular.


How to contain it?

What can be done to contain emerging protectionism? Many point to the Doha Round of the World Trade Organisation. Unfortunately, a deal on Doha would barely make a difference: current proposals—boiled down to a very low common denominator after seven years of bitter negotiations—would barely liberalise trade. Furthermore, they are a dog’s breakfast of exemptions and loopholes that could obstruct rather than facilitate international commerce. Finally, WTO agreements have much weaker disciplines on non-tariff protectionism than on tariffs. This will not change with a Doha deal.

What is imperative now is to prevent creeping protectionism getting out of hand. A Doha deal with stronger tariff bindings for developing countries might help contain tariff protectionism, but it will be nowhere near enough. Non-binding promises from the G20 and other large, unwieldy multilateral forums will not do the trick either.


Coalition of the willing

Preferably, a group of leading economies should form a “coalition of the willing” committing themselves in more concrete terms not to undertake new non-tariff protectionist measures. This should include refraining from trade-distorting subsidies to national producers. Such a coalition can only be built on leadership from today’s big economies – The United States, the EU and China chief among them.

Creeping protectionism is also intimately bound up with domestic economic policies, especially governments’ efforts to stimulate their economies. Preventing protectionism demands greater realism in overall economic policies. Fiscal stimulus -- the cynosure of the new policy consensus -- rests on a flimsy, crude Keynesian intellectual base. Its economics, as applied to current circumstances, is dubious enough; its political economy is appalling. It is naive to expect public-expenditure-led stimulus to be temporary and well-targeted to boost aggregate demand, while avoiding longer-term entitlements and wasteful pork-barrel spending. The latter is inevitable. In the real world, higher government spending means more discretionary powers for politicians and bureaucrats, indiscriminate subsidies, rent-seeking and corruption. Not least, it is bound to spill over into tit-for-tat international protectionism. Indeed, fiscal-stimulus packages are already providing cover for industrial-policy activism at home and protectionism abroad. Those who profess shock and horror at such developments are -- to put it charitably -- childishly innocent.

Finally, the new consensus espouses a renewed compact of “embedded liberalism” or “Keynes at home and Smith abroad” (Caplin 2008). Greater government macro and micro interventions at home are needed to stimulate recovery, reduce inequality and preserve social stability. And stronger international cooperation (or “global governance”) is needed to make this work in tandem with open markets abroad. This idea is based on a contradiction. Big Government at home means a new Age of Protection abroad. Keynes at home is also Keynes abroad. After all, Keynes turned to national self-sufficiency policies and protectionism in the 1930s – not least to make activist macroeconomic policies work at home.

Fredrik Erixon and Razeen Sally
Directors and founders of the European Centre for International Political Economy (ECIPE), a world economy think tank based in Brussels