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The Looming Threat of Protectionism and What It Tells Us About the Path Ahead

July 28, 2010

The Looming Threat of Protectionism ‘A Double Raid on UK Plc as Overseas Buyers Swoop’ was how the Evening Standard fearfully described both a recent bid by a US-Canadian consortium to buy British manufacturing firm, Tomkins, and the revival of merger talks between France’s GDF-Suez and the UK’s International Power.

That news of either deal would have raised eyebrows in alarm a few years ago seems unlikely. And yet how the coalition government reacts to the selling of these British assets to foreign buyers is being watched with close interest.

With the furore over the hostile takeover of Cadbury by American giant, Kraft, the attacks by the Obama administration on British Petroleum, and worry over the number of companies being sold to buyers from the Middle East, China, Russia and India, the ownership of business has become increasingly politicised. Against a backdrop of rising unemployment and deep seated economic unease at home, any perceived failure by a government to stand up for the ‘national interest’ against ruthless foreign invaders risks domestic uproar.

Unfortunately, however, I fear these awkward collisions between the worlds of business and politics are merely the outward manifestations of an underlying trend towards protectionism that is beginning to infect the global economy. But why the urge to batten down the hatches and what does it augur for the future?

I would contend that growing protectionism is in reality only a symptom of a far deeper, more fundamental anxiety – that of the colossal trade imbalances that the financial crisis has so painfully exposed (and which were in truth one of its main causes). How these might be overcome and what the world will look like once they have been unravelled may eventually tell the story of the global economy in this century.

Since the rapid unfurling of the global financial system in 2008, politicians have been anxious to avoid the policy mistakes that followed the banking crisis of the 1930s. Uncomfortably aware of the speed at which the Wall Street Crash of 1929 led to the Great Depression, focus has rested primarily on public spending. It is for this reason that we have been subject to the continual invocation of Keynesian economics when it comes to the bailing out of banks, quantitative easing and the maintenance of historically high levels of public spending.

Of rather less interest, however, seem to be the equally important lessons that the 1929-1933 era taught us about protectionism. As the global economy entered recession, the Smoot-Hawley Tariff Act of 1930 raised tariffs drastically on over 20 000 goods imported into the United States in a bid to protect American jobs from foreign competition. Initially the Act appeared a great success with domestic industrial production increasing sharply. However, while imports into the US dropped by 66% within only a few years, US exports also decreased markedly by 61% over the same period.

In essence this Act had sparked a domino effect amongst America’s trading partners who were provoked into imposing similar measures to protect their own domestic economies. The result was a slump in world trade that decimated economic growth and caused unemployment to soar. We need not be reminded of the political upheaval and military conflict that followed hot on the heels of those deep economic troubles.

It is with an eye to this dark historical period that world leaders have continued to reassert their commitment to free trade at each meeting of the G20 since 2008’s economic crisis. At the most recent summit in Toronto, further pledges to resist protectionism and avoid new barriers to investment and trade once again tripped easily off tongues. Yet these laudable promises disguised a rather less palatable reality that goes some way to explaining why the final declaration at the Canadian meeting reportedly dropped a promise to lift any protectionist measures that have been enacted since the economic crisis.

The truth is that since the global economy hit the skids, ailing nations have failed to resist domestic pressure to shield their own companies and workers from the coldest recessionary winds. Independent monitor, Global Trade Alert, has estimated that discriminatory measures applied worldwide since the beginning of the financial crisis now cover $1.6 trillion – a staggering 10% – of global trade. To reinforce this, a 2009 study by economists David Jacks, Christopher Meissner and Dennis Novy suggests that the costs and obstacles that exporters faced in 2008 and 2009 increased by almost the same scale as in the early 1930s.

Such costs and obstacles may not be the blatant protectionism of Smoot-Hawley, but they could still prove potent. Let us look at some specific examples.

First, the terms of the banking bailouts. When RBS was bailed out by the UK government, explicit clauses were inserted into the agreement that ensured that lending to domestic customers would be prioritised over businesses or individuals overseas. Similarly, in the United States foreign companies were restricted from accessing government bailout money and some important government contracts, and specific ‘Buy American’ clauses were inserted into the stimulus package. Granted, some of these measures were put in place to prevent leakage (in other words to guard against the drastic dilution of the stimulus effect in the event that government money was used to pay for cheap foreign imports or investment abroad). However, the provisions were palpably protectionism by the backdoor.

Turning to trade, the European Union has been putting ever more burdensome requirements on products and production processes that have been having an especially negative effect on developing countries’ ability to export to EU nations. The new Renewable Energy Directive, for example, has been branded green protectionism for its use of environmentalism as a fig leaf in favouring French and Spanish rapeseed producers over cheaper foreign competitors in the production of biofuels.

Meanwhile a war of words has erupted between European business leaders and the Chinese government over access to China’s domestic market. The President of the European Chamber of Commerce recently warned China that not enough is being done to create a level playing field for foreign businesses, a sentiment shared by the US Chamber of Commerce. New rules promoting ‘indigenous innovation’, for example, explicitly favour Chinese companies in government procurement and encourage the forced transfer of technological know-how or intellectual property as the price of foreign companies doing business in that country.

Recent disputes between the Chinese and high profile global companies, Google and Rio Tinto, have served only to heighten tensions. The arrest of senior Rio Tinto executives for bribe-taking happened to coincide with tough negotiations with the Chinese over the price of iron ore as well as Rio’s decision to pull out of a deal with a Chinese state-controlled firm. While the Rio Tinto employees have found themselves subject to a corruption trial, the Chinese felons have not been brought to book.

Eclipsing all these examples, however, is the increasingly fraught relationship between the United States and China. US politicians are under pressure domestically either to press vigorously for the revaluation of the yuan or else impose anti-dumping duties and countervailing tariffs on the cheap Chinese goods perceived to be undermining US exports and jobs. China, on the other hand, treats requests for currency revaluation and a reduction in protectionist measures as deeply distasteful. To their minds a nation so indebted is in no position to negotiate; nor should a nation that bails out its carmakers, enacts Buy American legislation or restricts Chinese companies from government contracts be regarded as being in any position to lecture others.

Perhaps alone none of these examples is critical. But in the event that nations across the world become convinced that others are retreating from free trade, the rush towards protectionism could prove highly contagious. We need only remind ourselves of the 1930s to grasp the economic and political implications.

Such a rush would only be the symptom of a much more fundamental problem – the overarching struggle between nations with trade surpluses, on the one hand, and nations with trade deficits on the other.

Countries such as China and Germany have enjoyed for some time export-led growth that has allowed them to accrue vast reserves. This has, of course, been achieved in large part by the industry and enterprise of their people. Yet both have undeniably benefited from currency manipulation too. For some time the undervalued Chinese yuan has viciously undercut foreign competition. Meanwhile the adoption of fixed exchange rates within the Euro by Germany has kept that nation’s relative labour costs competitively low. Both countries have also relied upon the willingness of neighbouring countries to buy their goods, lending vast sums to its trading partners if necessary to fund their imports.

Over the past decade or so these deficit countries – the United States and Britain, above all – have undoubtedly enjoyed the cheap goods and easy money. But when the financial crisis hit, the resulting indebtedness was sharply exposed. They have therefore spent the past two years uncomfortably realigning expectations and slowly coming to terms with a new reality of constrained spending. But they are also gradually beginning to ask why they should continue to provide a dumping ground for cheap exports and burden future generations with vast debt simply to provide Chinese and German jobs. It is these questions that are beginning to manifest themselves in the rhetoric of economic nationalism and the increasing allure of protectionism.

Having convinced themselves of occupying the moral high ground, however, surplus nations are asking questions too. Why should they relinquish economic power by unleashing some of their surplus and why should they look again at currency revaluation at the risk of undermining export-led employment? As these issues are grappled with, so we see greater economic bullishness from the likes of China and an assertion of the right to protect jobs and favour companies domestically.

In truth, however, both predicaments reveal the mutual symbiosis of today’s global trading relationships. By definition, not every country can have a trade surplus and those that do have now been made aware that any deep imbalance in their relationships with trading partners can leave the lender as vulnerable as the debtor.

The path ahead for the global economy therefore presents a choice – the massive trade imbalances can continue or somehow a healthier equilibrium has to be found. The first scenario is vulnerable to shocks, as we have seen. But the second inevitably entails the tense unravelling of trade imbalances.

In the face of such adjustment from both deficit and surplus nations, protectionism is deeply tempting. The combination of fear, anger, xenophobia, nationalism and anxiety over each country’s role in an ever competitive world, could suck the global economy into a dark spiral that, in the worst case scenario, could prove the precursor to more physical conflict. Unfortunately the less immediately perceptible benefits of global trade are far harder for politicians to articulate to anxious countrymen than the emotional pulls of national pride and the easy political capital to be gained from standing up against foreign competition in the face of rising unemployment.

It is for these reasons that it becomes ever more vital that the World Trade Organisation and national, political and business leaders make the case in the years ahead for the massive benefits of free trade. Efforts to roll back the protectionism of the past two years and break down the remaining barriers of all kinds to trade in goods and services must be redoubled. Only then will the path to prosperity become clearer for all.