No Walls In This Street

One of the greatest fears facing the world as it entered the financial crisis a year ago was the potential aftermath of protectionism in the form of rising trade barriers. But, while many cited the beggar-thy-neighbor policies that spawned the Great Depression as the next shoe to drop, these prognostications largely did not come to pass. True, there have been some “Buy [place country here]” policies, but the escalation of protectionist measures many economists feared simply did not occur. There are three reasons for this: the interdependence created by global trade; the existence of the WTO; and rising importance of the supply chain in the composition of the world economy. So much of an individual country’s economy depends on goods and services from other trade partners, erecting barriers today is like shooting oneself in the foot. The WTO, imperfect as it is, provides a forum where unfair or protectionist measures can be redressed, limiting a vicious cycle of retaliation. And finally, the world economy today relies less on agriculture, thus diminishing the number of people who could benefit from any protectionist measures. Indeed, when economics and politics collide, the temptation for protectionism remains. But given today’s interconnected world, politicians are likely to think twice before erecting hard barriers. – YaleGlobal

No Walls In This Street

Contrary to fears, the meltdown has not spurred protectionism in this interlinked world

Nayan Chanda

Monday, August 31, 2009

Almost a year into the global economic crisis, it is time to consider the dog that did not bark. Since Wall Street imploded in September 2008, triggering a global recession, there have been dire warnings against protectionism. Many, including myself, saw the world facing the risk of a 1930s-style beggar-thy-neighbour policy that would drive the recession into another Great Depression.

But now it appears we have overblown the fears. The under-appreciation of global interconnectedness, which once fed the theory of ‘decoupling’, may have led others to exaggerate the power of countries to put up protectionist walls. While protectionism’s allure as a tool to combat unemployment remains undiminished, most countries are now too interdependent to employ trade barriers.

Protectionist rhetoric has risen in direct proportion to the deepening crisis in the developed world. But a survey of trade measures undertaken in the past nine months shows the actual impact to have been rather limited. In July, the Global Trade Alert, a portal that tracks trade-restricting measures globally, listed 67 measures with indistinct consequences. The report said the measures taken by countries such as India, Indonesia and the US could affect hundreds of countries. However, the tangible impact of such measures has been minimal until now — so much so that economist Patrick Messerlin has warned that crying wolf could end up helping protectionists.

In their recent report, ‘The Fateful Allure of Protectionism: Taking Stock for the G8’, Messerlin and fellow economists explain why the feared protectionist tsunami has not occurred. One of the main reasons is that governments today are not bound by the fixed rates of the gold standard era and the orthodoxy of balanced budget. As a result, they have more policy tools to revive the economy, and need not seek shelter behind protectionist tariffs. Today’s governments, free from such constraints, have deployed the tools of fiscal stimulus. They have pumped vast sums of money into the financial system to jump-start the global economy.

Perhaps the most important counter-protectionist factor has been the World Trade Organization (WTO). The habitual critics of the organisation should note that had it not been there with its threat of sanctions, many countries would surely have launched protectionist measures, triggering retaliation and countermeasures that could have precipitated a Great Depression.

The existence of the WTO, however imperfect its mechanism, has allowed trade to grow fast. Over the past 30 years, the simple average of trade-to-GDP ratio has grown from 55 per cent to 96 per cent. The changing nature of the world economy, with agriculture and manufacturing increasingly becoming the less critical components of GDP, has meant that fewer workers are directly affected by trade barriers.

Consequently, protectionist measures bring only limited benefits — that too at high cost. Trade safeguards offered to countries affected by foreign imports have acted as guardrails against protectionism. A case in point is the relief provided to countries when China joined the WTO. When the end of multi-fibre agreement produced a surge of Chinese textile exports to the US and Europe, WTO allowed safeguards against Chinese exports for a three-year period.

Similar provisions may be accorded to the US tyre manufacturers affected by cheaper Chinese tyre imports. While denounced as protectionist in intent, the circumscribed nature of the safeguard measures provides a short-term cushion that could help protect free trade in the long term.

The changing nature of the growing trade too has imposed new restraints on governments tempted by the easy solution of tariff barriers. In the past two decades, distributed manufacturing methods and the rise of large-scale supply chains have seen trade in parts and components more than double as a proportion of total trade. With the economies of the world being integrated and interdependent, trade action against one partner could produce unanticipated consequences on another sector of the economy. Hence, it is no coincidence that the countries that have taken trade restrictive measures are mostly the ones with limited involvement in the supply-chain economy.

As the crisis continues, countries will keep flirting with protectionism. On present evidence, however, it looks as though they will think carefully before stumbling into a potentially ‘un-winnable’ trade war.

Nayan Chanda is director of publications at the Yale Center for the Study of Globalisation, and Editor of YaleGlobal Online.

http://www.businessworld.in/bw/2009_08_29_No_Walls_In_This_Street.html