Protectionism: Alluring but Deadly

Friday, March 13, 2009 

By Daniel Ikenson 

protectionimsThe global economic meltdown has prompted fears of resurgent protectionism and some governments have already raised tariffs and other trade barriers. But, despite the occasional dalliance with protectionism, treaties and good sense prevent a more serious romance.
Amid pledges of restraint from the big economies, India recently raised tariffs and placed other restrictions on some imported steel products. Ecuador raised tariffs by 5 to 20 per cent on 940 products. Argentina’s restrictions include auto parts, textiles, televisions and shoes. And the Indonesian government is requiring civil servants to purchase only domestic products.
Similar actions have taken place in other countries and surely there will be more in the months ahead. But the risk of protectionism escalating to the point that it noticeably reduces global trade further is remote.
With the proliferation of international production, investment and joint ventures, the "Us versus Them" characterization of global competition no longer applies. It is now a competition between global supply chains to produce and deliver products made with parts and labour from many countries. The successful supply chains are those with the fewest constraints–physical and administrative, including trade barriers.
According to recent estimates from the International Food Policy Research Institute, a US think-tank, if all World Trade Organization members raised all tariffs to their maximum allowable rates, the average global tariff would double and trade would decline by 7.7 per cent over five years, from the 5.5 per cent growth this decade. But, to put 7.7 per cent in historical context, the value of global trade plummeted by 66 per cent between 1929 and 1934, in the wake of the protectionist plague following the US Smoot-Hawley Tariff Act in 1930.
In the 1930s there were no global rules, no sources of adjudication or remediation, and no generally accepted limits to unilateral actions by governments. And there were far fewer domestic constituencies of any political consequence protesting against protectionism in the ‘30s.
Now we have trade rules that work reasonably well and a vastly different global economy that makes import restrictions much more expensive to the country imposing those restrictions. Most WTO members apply tariff rates well below their required or "bound" rates, a good indication that governments have little interest in the protectionist past.
Today there are burgeoning domestic constituencies in numerous countries who favor lower tariffs because their livelihoods depend on access to imported raw materials, components, and capital equipment. When governments raise trade barriers, they deter foreign investment and reduce the appeal of their countries as locations for research, production, or assembly operations in the supply chain.
That dynamic is easier to appreciate when one considers that 55 per cent of all US import value in 2007 consisted of raw materials, intermediate goods and capital equipment–the kinds of products the construction and manufacturing sectors purchase. Put in this light, it is more obvious that tariffs raise the costs of production, which undermines economic growth–or, as in the current case, economic recovery.
Mexico, for example, understands this. In January it started cutting rates on about 70 per cent of its tariff schedule. Those 8,000 items comprising 20 different industrial sectors accounted for about half of all Mexican import value in 2007. The objectives are to reduce business operating costs, attract and retain foreign investment, raise productivity and give consumers more, better and cheaper goods and services.
Mexico is not alone. In February, Brazil suspended tariffs entirely on some capital goods and reduced duties to two per cent on a wide variety of machinery and capital equipment, including communications and IT.
Some analysts worry less about border barriers and more about camouflaged protectionism that favours "domestic champions," discourages competition or encourages "buying local." It’s not Thirties-style, tit-for-tat trade wars that they fear but Seventiess-style government intervention that will limit choices, stymie competition, and strangle growth.
That kind of protectionism is already in evidence and, because it is more opaque, is more prone to abuse. But, like tariffs, those kinds of policies are unsustainable because they will undermine trade, investment and economic growth.
Governments that stimulate innovation and competition offer their people the greatest opportunity to recover in our global economy.
Daniel Ikenson is associate director of the Center for Trade Policy Studies at the Cato Institute in Washington.