Protectionism Makes Comeback as Recovery Stalls

Protectionism could resurface as a result of lackluster growth in industrialized countries.

Almost three years after the bricks of Wall Street crumbled, projections for growth in 2012 are more pessimistic than ever, as noted by the recently published Global Economic Prospects 2012 of the World Bank.

The effects of Europe’s spiraling debt crisis are felt across the developed and the developing world, countering the perception that emerging economies could be the motor of a global recovery. The imminent change of leadership in many countries, including China, France, Mexico and the United States, will make the foreseeable future a highly unstable one. In the upcoming months there will be an increase in populist policies and rising fiscal deficits. Governments may pay more attention to their constituencies which have been suffering the ongoing negative economic panorama.

As a result, protectionism could gain weight in the upcoming months and while it may be vilified by conventional wisdom which rightfully points out the benefits of free trade, there is a “human face” which legitimizes it.

Supporters of protectionism tend to justify their demands through what they regard as the direct negative effects of trade with other countries. Some of these effects are caused by the “unfair” practices of governments as China’s. Others are due to the abundance of cheap labor in countries as Mexico.

Whatever the reason, according to protectionists unchecked trade liberalization causes unemployment and income inequality. America’s disturbing trade deficit with China is one of the favorite arguments of trade critics in the United States. These opinions have a considerable impact in various segments of the population. The 2008 financial crisis only helped enforce the notion that Americans industry ought to be protected from unfair competition overseas.

According to theory, trade liberalization benefits an economy by expanding its production capabilities and diversifying the goods it can consume. Trade dynamics promoted by international competition lead to a decrease in prices, benefiting consumers and producers alike.

It also expands the labor pool, thereby reducing costs. Trade leads to specialization. Every country has a comparative advantage in producing certain type of goods due to its factor endowment. An economy will specialize in the production of goods which uses intensively its relative abundant factor. Thus, Germany, which is relatively abundant in high skill labor, specializes in the production of high end goods (computers, pharmaceuticals, etc.), while Vietnam, which is relatively abundant in low skill labor, specializes in the production of basic goods (agricultural products, clothes).

Through specialization, countries are able to increase their respective national income because they produce what they are more efficient in producing and trade it to the world. But then, what happens to those industries in which a nation is inefficient? Herein lays the main dilemma of trade which can fuel protectionism — specialization leads to the disappearance of inefficient industries. Theoretically, this should not be a problem, since workers in these industries will gravitate to other industries which are succeeding. Reality is more complex.

Skill biased technological change has made it very difficult for job displacement to occur. All types of jobs have modified their requirements in line with technological chance. A laid off worker will struggle to find another job because he doesn’t have the required set of skills. Retraining could take years. The protectionists argue that this is exactly why the state must design and implement policies to offset those effects of liberalization.

It’s easy for Americans to blame the Chinese for their trade deficit, to propose to punish China by turning its currency manipulation into an illegal subsidy and disregard recommendations to change domestic consumption patterns which, in fact, makes American society the main actor responsible for their current situation.

A more effective way to enable economic growth than either raise or reduce trade tariffs may be the implementation of an industrial policy. This refers to measures introduced by governments to channel resources into sectors which they view as critical to future economic growth. It implies benefiting some by hurting others (the financial resources have to come from somewhere else). Consequently, industrial policy should only be deployed to counter market failures and externalities which prevent the industries in which a country has comparative advantage from naturally becoming as efficient as they should be.

The successful examples of Japan, South Korea and the Southeast Asian “tiger” economies encourage governments around the world to intervene in their industries through subsidies, tariffs, taxes, etc. so as to increase their profitability. The idea is to benefit those sectors that the state believes have a comparative advantage over those of other countries and create national champions

There are problems with this analysis. Japan and South Korea both had the overt support of the United States which, due to Cold War dynamics, prevented their experiments from failing. For their part, the tigers, except Hong Kong, had authoritarian governments that facilitated the implementation of policies and they, too, enjoyed American support.

There are examples that demonstrate both successes and failures but, to be fair, the outcomes were contingent upon other variables which require closer analysis. China’s is the most recent case of an industrial policy, and, so far, it seems it has been successful.

This has caused alarm in the United States where China’s success is increasingly perceived as coming at the expense of American workers. The politicization of industrial policy that aims to “correct” market imbalances unfortunately often leads democratic governments to privilege certain interest groups, whether they’re corporations or unions, at the expense of their economy’s competitiveness as a whole. Perhaps, in this sense, China’s comparative advantage is its very authoritarianism?

Both supporters and detractors of protectionism tend to frame their arguments so as to cause the largest possible impact on public opinion. This is because protectionism has a “human face” embedded within it. For many sectors within society, protectionist policies are regarded as a solution to their grievances. With little regard for theory and the long-term negative effects of poorly planned protectionist policies, they suffer from what political analysts call “shortsightedness.”

Governments should always bear in mind how to increase efficiency and productivity when intervening and implementing protectionist policies. Industrial policy demonstrates that this is very difficult and that many other variables are at play. By politicizing trade, protectionism becomes the vilified entity that economists so hate — short-term solutions with long-term negative consequences.

This article would not have been possible without the insights received when attending Georgetown University’s course imparted by Professor Theodore H. Moran, “Globalization: Challenge for Developed Countries.”