Save us from Protection

Friday, February 06, 2009 

By Fredrik Erixon & Razeen Sally

Razeen Sally (L) and Fredrik Erixon (R)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 it is a replay of the creeping protectionism of the 1970s that we should worry about.

Protectionism in the 1930s involved tariffs and hit fragile trade patterns badly. But the world economy has changed since then and so have the preferred tools of protectionists. Even the most bone-headed legislator understands that, with globalised supply chains, you will damage your home firms’ competitiveness if you trigger tariff reprisals.

The lesson from the 1970s is different. Crises such as the collapse of the gold standard and the rise of oil prices marked the end of a long boom and triggered government intervention, with new labour-market and capital-market regulations. Subsidies were sprayed at ailing firms and whole sectors. These domestic interventions exacerbated an initial crisis, prolonged stagnation–and spawned protectionism. Industry after industry, coddled by subsidies at home, sought protection from foreign competition. The result was the "new protectionism" and "managed trade" among rich countries in the 1970s and 1980s.

The parallels between then and now are clear. The corporate welfare queens of the 1970s, such as Chrysler and Rolls Royce, are back on handouts, like car-makers in other countries. European Union rules on state aid have been relaxed. In the United States, the new Administration may include "Buy America" provisions in its fiscal stimulus package. Russia has already introduced such provisions. In countries as different as China and France, "strategic" sectors and "national champions" have been sheltered from foreign investors.

This is creeping protectionism. It is not an open declaration of trade war using tariffs but protectionism with non-tariff weapons.

The United Nations Conference on Trade and Development has recorded an increase in new laws unfavourable to foreign investment, a quarter of all new investment laws since 2005, compared with only 7.5% from 1992 to 2004. These restrictions are primarily in energy sectors but are spreading. China, for example, has restricted foreign investment to protect national champions in industry, energy and services.

"Green protectionism" poses yet another threat. The European Union already has an emission-trading scheme and the Obama Administration still seems to favour the idea. 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.

These barriers to trade and investment have been increasing for some time but now get a boost as a panic response to the economic downturn.

What can be done to prevent protectionism crippling economies, with its restriction of trade and its heavy costs for producers, consumers and taxpayers? Many point to the Doha Round of the World Trade Organisation. Unfortunately, a deal on Doha would barely make a difference: current proposals were boiled down to a very low common denominator after seven years of bitter negotiations. 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 powers against non-tariff protectionism than tariffs.

Two things are crucial at this point.

First, it is imperative to prevent creeping protectionism getting out of hand. A Doha deal would help against tariffs but it would not be enough. Non-binding promises from the G20 and other large, unwieldy multilateral forums will not do the trick either.

Ideally, a group of leading economies should form a "coalition of the willing" committing themselves clearly not to undertake new tariff or non-tariff protectionism, such as 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.

Second, and more medium-term, the global engine of bottom-up, unilateral liberalisation must be revved up again. In the last 20 years, unilateral liberalisation by developing countries has been twice as effective as multilateral agreements, benefitting economies as different as the Baltic countries, Chile, China and India. There are precedents: crises in the late 1980s and early 1990s led to the freeing of economies and trade, allowing sustained growth.

Instead of bail-outs and state spending, governments must embrace the economic freedoms that will speed up recovery.

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