Even though they shouldn’t, all countries protect some inefficient industries.  But protection has declined substantially over the past 60 years and the major remaining problem area for most advanced countries is agriculture.

But the battle is never won.  Different industries are always lobbying governments for special favours, especially in times of crisis.  They will use all sorts of arguments, and argue for all sorts of schemes.  And governments are always tempted to give in, particularly when elections are coming.

While there are many ways to implement protectionism, governments are often tempted by the path of “murky protectionism”, that is, protectionism that somehow lacks clarity or distinctness, or is cloudy or obscure.

If you are going to protect an industry, subsidies are the best measure.  They distort production because the recipients of the subsidies gain an advantage over other (more efficient) producers in the economy.  But subsidies can keep final prices at the same level as free trade prices, which mean that consumers are not adversely affected – although poor taxpayers must foot the bill for the subsidies.

Then there are tariffs, which are basically a tax on imports.  As they jack up the price of imports, consumers are encouraged to switch their demand to local products.  While local producers win, they do so at the price of the rest of the economy, which does not enjoy this favour, and also at the price of consumers who can no longer buy the product at free trade prices.  The government gets tariff revenues, but it is an inefficient way to raise public revenues.

Import quotas are another form of protection.  They might, for example, limit the number of imported cars.  This pushes up the price of cars, and thereby ultimately acts like a tax on imports.  The actual implicit tax effect of quotas is less clear and transparent than in the case of tariffs.

Once you go beyond these measures, you move into the world of murky protection.  Today, in the midst of financial crisis, a number of governments are implementing murky forms of protection.  This can take many forms.  Examples include use of health and safety regulations to restrict imports, clauses in stimulus packages that confine spending increases to domestic producers ("Buy America"), or ‘green protectionism’ like the clause in the recent US stimulus legislation that appropriates funds for advanced batteries and components, but only for manufacturers located in the US.  Antidumping measures, which are also up sharply, are rather murky.

The recent bailout packages are another source of murky protectionism. For example, UK banks receiving bailouts were encouraged to redirect lending towards the home market; French banks were encouraged to lend to airlines that might otherwise cancel Airbus orders.  The US automotive sector bailouts are another case of murky protectionism that provoked assistance bailouts in a string of other countries.  French President Sarkozy remarked "The situation in Europe means that you cannot accuse any country of being protectionist when the Americans put up $30 billion to support their automotive industry."

The assistance given to the American automobile industry was scandalous.  We all knew that something was wrong when the CEOs of America’s leading automobile companies took a private, VIP jet to Washington to beg for assistance!  Why didn’t they drive in one of their cars?

But as President Obama said, "the nation that invented the automobile cannot walk away from it."  So, the CEOs were bound to walk away with full pockets of greenbacks.  If the Wall Street golden boys get assistance, why not the automobile industry?

Sure, the auto industry has been hit hard by the crisis (haven’t we all?).  It tends to suffer from big swings around the business cycle.  When the economy turns down, demand for autos turns down even more sharply as consumers delay buying a new car.  (But when the economy turns up again, the demand for autos goes up even more sharply as we all celebrate by buying a new car.)

It is true that the auto industry is important in our economies -- not so much by itself, but through the whole value chain.  Downstream there are car financing services, insurance and maintenance, and upstream there is steel and all the other raw materials.  And what’s more, it doesn’t only concern big companies.  Many components in the supply chain are made by small enterprises.  Automobiles account for some 20 per cent of Japan’s exports, compared with only 6 per cent for the US

It is also true that auto industries tend to be concentrated regionally like Detroit in the US or Nagoya in Japan.  This means that downturns create regional problems and the poor laid-off workers have nowhere to go to find a new job.  There is also an important blue collar dimension to the auto industry.  This means that laid-off workers may find it difficult to train themselves into becoming computer programmers to find a new job.

But the main point is that inefficient industries tend to get most hit by economic downturns.  Worldwide, the automobile industry has massive overcapacity (which is not being cut back because of the assistance).  And the old Big 3 from America, General Motors, Ford and Chrysler have been badly managed for years.  They could not keep up with fuel efficient innovation by Toyota, a fact highlighted by the 2008 increase in oil prices.  And they lumbered themselves with large pension and health care liabilities to their workers.

In addition to direct assistance to automobile companies, many governments have tried to encourage purchases of automobiles through schemes like "cash for clunkers" which encourage consumers to trade in their old fuel inefficient automobiles for fuel efficient ones.  But as the OECD points out, the evidence demonstrates that such schemes usually encourage consumers to merely bring forward the timing of their automobiles purchases.

The assistance given worldwide to the automobile industry defies the great lesson of the Great Depression.  That is, protectionist measures by one country push all countries to do the same thing, and for industries like the automobile industry, it just pushes back the day of reckoning.  Advanced country markets will likely be stagnant in the coming years, with most growth coming from emerging economies like China and India.  And all this assistance money is one of the reasons why government debt is now through the roof in too many countries.

The most offensive form of murky protectionism is the “China-free” product movement which has arisen in light of health and safety scares regarding Chinese-made food and products.  The idea is that China-free products should be labeled as such (this is not of course a government-led initiative!).  It was reported that a US-based company called Food for Health International has announced plans to put "China-free" stickers on its goods.  Vitamin brand Opurity's overall messaging is not any less dramatic than its ads: "China Free Multivitamin Choice".  There is only one problem – virtually no product today is China-free!

The Great Depression demonstrated the folly of protectionism as a response to crisis.  In 1930 the so-called Smoot-Hawley Tariff raised U.S. tariffs on over 20,000 imported goods to record levels.  These tariffs were designed to protect US industry.  But the main impact came from retaliatory tariffs by US trading partners.  Protectionist policies in the 1930s intensified the Great Depression and delayed economic recovery. Global trade volumes fell by 25 percent during 1929–33, with about a third of this attributable to higher trade barriers.

This time around, one of the major impacts of the global financial crisis was to provoke the “great trade collapse” in 2008.  Global trade volumes fell by 17.5 percent between September 2008 and January 2009 (much more than GDP).  This trade collapse was due to three main factors.  First, demand for investment goods and consumer durables was hardest hit by the crisis as consumers delayed purchases and firms shelved investment plans.  Second, there was a multiplier effect of reduced trade in global supply chains as components are traded several times in producing a final product.  The third factor was reduced availability of trade finance.  By mid-2009 trade had started to recover, and global trade rose 25 percent between May and December 2009, returning to some 90 percent of September 2008 levels.

The sharp contraction of trade raised high-level awareness of the prospect of resurgent protectionism. The 1930s experience illustrated how increased protectionism could exacerbate a crisis and delay recovery.  It was the memory of this madness that inspired G20 leaders to stand firm against protectionism in their three summits of the past year or so.  In Pittsburgh last September 2009, they said:

“Continuing the revival in world trade and investment is essential to restoring global growth. It is imperative we stand together to fight against protectionism. We welcome the swift implementation of the $250 billion trade finance initiative. We will keep markets open and free and reaffirm the commitments made in Washington and London: to refrain from raising barriers or imposing new barriers to investment or to trade in goods and services, imposing new export restrictions or implementing World Trade Organization (WTO) inconsistent measures to stimulate exports and commit to rectify such measures as they arise. We will minimize any negative impact on trade and investment of our domestic policy actions, including fiscal policy and action to support the financial sector. We will not retreat into financial protectionism, particularly measures that constrain worldwide capital flows, especially to developing countries. We will notify promptly the WTO of any relevant trade measures. We welcome the latest joint report from the WTO, OECD, IMF, and United Nations Conference on Trade and Development (UNCTAD) and ask them to continue to monitor the situation within their respective mandates, reporting publicly on these commitments on a quarterly basis.”

So are the G20 countries living up to their commitments to refrain from raising barriers or imposing new barriers to investment or to trade?  According to the recent joint WTO/OECD/UNCTAD report, “there has been no indication of a significant intensification of trade or investment restriction since the last Report to the G20 in September 2009”.  Although some G20 members continued to implement new trade restrictive policies, in apparent contradiction to their pledges at London and Pittsburgh, the overall extent of these restrictions has been limited and an escalation of protectionism has continued to be avoided.

But even if the level cheating is low, we have to be vigilant about the future.  As this report says, “past experience shows that prolonged periods of job losses and unemployment are one of the main catalysts for more restrictive policymaking”.  And while the IMF has just released an upbeat set of forecasts for the world economy, unemployment is projected to remain high for some time, especially in Europe.  Moreover, unemployment rates are highly vulnerable to further new shocks.  In short, the G20 governments must do their utmost to do as they promise -- “oppose protectionism, to devise and announce publicly as soon as possible exit strategies from any trade restrictions or other measures with trade restrictive or distorting effects that were taken in response to economic conditions last year, so as to undercut protectionist pressures in favour of making these measures permanent.”.

The Global Trade Alert’s 4th Report, released a few weeks earlier, suggests that the WTO/OECD/UNCTAD report may have been going soft on the G20 governments.  The GTA dismisses any suggestion that 2009 was a low protectionism year.  The number of protectionist measures implemented in 2009 is now estimated to be higher than originally thought.  A conservative estimate is that in total governments resorted to protectionism measures roughly 100 times every 3 months before the macroeconomic stabilisation of late 2009.  And this stabilisation certainly hasn't ended protectionism.

A more recent IMF paper also has a more critical assessment of recent protectionist moves.  They estimate that new trade restrictions have had—in the limited products they targeted—a strong negative impact on trade.  Fortunately, these restrictions have covered only a small share of trade.  Thus, there is a genuine risk that if protectionist measures become widespread or are allowed to balloon, this would cause significant harm to global trade and stifle the broader economic recovery.  Gaps in World Trade Organization (WTO) commitments leave ample scope to further restrict trade.  Continuing and further enhancing the monitoring of all protectionist measures and maintaining the high-level political awareness of the associated macroeconomic risks will help.

None of these watchdogs suggests that we have—or likely will—see an extreme protectionist surge as witnessed in the 1930s. But protectionism is certainly something we need to be worried about.  Continued monitoring and naming and shaming by the watchdog organisations is necessary to keep the heat on governments to refrain from protectionism.

References:

The collapse of global trade, murky protectionism, and the crisis: Recommendations for the G20 by Richard Baldwin   Simon J Evenett. 5 March 2009

http://www.voxeu.org/index.php?q=node/3199

G20 Leaders Statement, Pittsburgh Summit, September 24 – 25, 2009

http://www.pittsburghsummit.gov/mediacenter/129639.htm

OECD, WTO and UNCTAD renew calls to G20 to resist protectionism

http://www.oecd.org/document/60/0,3343,en_2649_34529562_44741628_1_1_1_1,00.html

IMF World Economic Outlook, Rebalancing Growth, April 2010

http://www.imf.org/external/pubs/ft/weo/2010/01/index.htm#ch1fig

The 4th Global Trade Alert Report

http://globaltradealert.org/gta-analysis/will-stabilisation-limit-protectionism-4th-gta-report?top-ad

Trade and the Crisis: Protect or Recover by Rob Gregory, Christian Henn, Brad McDonald, and Mika Saito.

IMF Staff Position Note

http://www.imf.org/external/pubs/ft/spn/2010/spn1007.pdf

Remarks of President Barack Obama, Address to Joint Session of Congress, Tuesday, February 24th, 2009

http://www.whitehouse.gov/the_press_office/remarks-of-president-barack-obama-address-to-joint-session-of-congress/

The Automobile Industry In and Beyond the Crisis, OECD Economic Outlook, Chapter 2. January 2010.

http://www.oecd.org/dataoecd/57/61/44089863.pdf

China-free websites

http://www.chinafreechristmas.info/

http://china-free-products.blogspot.com/