The Fallacy of Protectionism

GENEVA: Protectionism has been described as "the dog that didn't bark" in the long, troubled night of the financial crisis; remarkable precisely because of its absence.

In the years since the crisis erupted, the world economy has borne witness to spiking unemployment levels, to Europe's debt woes, rising food prices, sluggish growth in the United States and now a slowdown in emerging countries. But one feared scenario has not materialized: a big wave of 1930s-style trade protectionism.

In late 2008, with financial markets in free fall, many dreaded a repeat of the Great Depression, complete with spiral of tit-for-tat trade restrictions. Global trade was collapsing at a startling pace, squeezed by declining demand, plummeting commodity prices and a credit crunch-induced scarcity of trade finance. In the space of six months, world merchandise trade fell by almost 20 percent, wiping away nearly four years' worth of growth.

To be sure, there have been worrying signs of the traditional propensity of nation-states to turn inwards when the global economic outlook is bad. Some major economies introduced a raft of restrictive measures, such as trade remedies, new licensing requirements for imports and state aid to industry. The aggregate scope of these measures, however, has been limited.

Why was this?

First, governments understood that fiscal and monetary policies can stimulate domestic demand, and used both to considerable effect. In the early 1930s, as many economists have noted, most governments were still trapped in fiscal and monetary orthodoxy. Tariffs were one of few policy levers visible to them – a lever that many pulled, in desperation to show that they were doing something about mass unemployment.

Second, two decades of rapid international integration – and, crucially, awareness of growing interdependence – meant that policymakers appreciated the merits of keeping economies open.

This interdependence is linked to the final important factor that contained protectionism in the midst of the crisis: the rules, norms, and transparency offered by the World Trade Organization.

The internationalisation of production that had so visibly bound economies together prior to the crisis was underpinned by the predictable trading environment provided by WTO rules. When the crisis broke, the WTO's combination of monitoring and surveillance and a firm framework of rules worked to deter knee-jerk protectionism.  Since January 2009, the WTO has issued regular reports on governments' use of trade restrictive measures. Together with the United Nations and the Organization for Economic Co-operation and Development, the WTO monitors how the Group of 20 leading economies comply with their pledges to refrain from trade and investment protectionism, documenting new policies to restrict or facilitate trade.

In sum, trade tensions have increased, but trade wars have been absent. Governments introducing import barriers have, in the main, cited the WTO rulebook to justify the moves. Countries feeling wronged by the measures have responded not with unilateral retaliation, but by using the WTO's well-tested litigation procedures. The WTO has proved its worth as a collective insurance policy against the disorder of unilateral action.

Yet we cannot be complacent. Dark clouds loom on the horizon for trade. Gloomy growth forecasts suggest that export demand may fall short of governments’ hopes. The WTO recently had to revise downward projections for trade volume growth in 2012 to 2.5 percent, down from 3.7 percent in spring. So long as unemployment remains stubbornly high – the International Labour Organization forecasts that in 2013 an additional 7 million people will join the 200-million-strong ranks of the unemployed – pressure to curb imports will persist. In addition, many major economies are already testing the political limits on the use of fiscal and monetary stimulus. If policymakers feel that these policy options have run their course, protectionism may regain its allure.

Already there is growing cause for concern. Our monitoring work indicates that governments continue to introduce new trade restrictions without stepping up the removal of older measures. The trade restricting measures introduced by G-20 governments since October 2008 now cover almost 3 percent of total world merchandise commerce – an amount roughly double Brazil's share in global trade. Trade restrictions have a tendency to shift from temporary crisis-fighting measures to industrial policies that are more difficult to unwind. Procedural and administrative roadblocks at borders are making traders' costs unpredictable. Perhaps more ominously, protectionist rhetoric favouring import substitution as a growth strategy is enjoying a revival even in some G-20 member countries.

The visible danger today is of a gradual but steady erosion of the benefits of trade openness.

The irony is that in the modern global economy, creeping protectionism is not a successful recipe for achieving its main goal, that is, to boost exports. Thanks to the dramatic rise in the fragmentation of production across countries, the import content of exported goods has doubled in the past 20 years to 40 percent. Intermediate goods, not final products, now account for more than half of global trade. We no longer trade in products, but in tasks. In a world of global value chains and ‘Made in the World’ products, impeding imports amounts to shooting your own exporters in the foot. Consumers struggling with stagnant wages would see their purchasing power weakened further. Developing countries could see hard-won gains rolled back.

If governments are to maximize the contribution of trade to better jobs and improved living standards, they must reframe the narrative surrounding it. The traditional “imports bad/exports good” framework needs to give way to “export success depends also on easy access to imports.” The focus must be on adding value, not crude bilateral trade balances. To support such efforts, the WTO has been working with partners such as the OECD to develop statistics that reflect trade in value added; the first batch of numbers is due in December.

In the shorter term, there are concrete steps governments could take to keep international trade flowing. Unwinding recent restrictions is an obvious starting point. Although the broader Doha Round negotiations are currently at an impasse, countries could move forward towards a WTO agreement on trade facilitation, which would lower trading costs by slashing customs-related red tape and simplifying border procedures for traded merchandise. They could cooperate on how to minimise the trade costs or distortions arising from divergence in non-tariff measures without compromising the pursuit of health, safety or environmental objectives. Governments could also work together with the Basel regulators to ensure that much-needed banking sector regulations do not unintentionally make trade finance less available and affordable, especially for poor countries.

Over the long run, domestic social policy will be central to resisting protectionist backlashes and keeping trade open. Trade will always be vulnerable if the efficiencies it creates are perceived to benefit only a fortunate minority. Government action can help equip people to profit from the global marketplace, cushion the blows of creative destruction and curb inequality.

A crisis is an opportunity to learn. In a world where protectionism does not protect governments must take more sophisticated approaches to supporting domestic growth and social protection. It is important that this be one of the fundamental lessons that we collectively learn from this crisis.