If Protectionism is Self If Protectionism is Self Defeating, why is it on the Defeating, why is it on the Increase?Increase?

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Dr. Charles Dr. Charles SmithSmith

• In the field of international trade there are winners and losers.

• One country’s balance of payments surplus is, in a sense, another country’s deficit.

• The total balance of payments of accounts for every country in the world should logically sum to zero.

• The terms of trade measures the ratio of world prices of a country’s exports to the world prices of its imports.

• It is possible for the terms of trade to move so that one country trades at the expense of another country.

• Since the 1970s, the terms of trade have enabled oil-exporting countries to pile up balance of payments surpluses on a yearly basis.

• Countries exporting oil and importing just about everything else have done very well for themselves.

• While many oil-importing countries have tended to have repeated deficits.

• Countries that rely on a narrow range of exports whose prices have either risen slowly, or fallen on world markets, have struggled to purchase a wide range of imported goods and services.

• However, Economics tells us that international free trade is not a zero-sum game, but a win-win activity in which all participants can benefit.

• According to Adam Smith and David Ricardo the point of international trade is to enable countries to benefit from gains arising from specialisation.

• If a country is better at producing potatoes than tomatoes it makes sense to put more resources into potato production, and to export some potatoes to pay for imports of tomatoes.

• This is the right thing to do even if the country is the world’s best producer of tomatoes as well, because it will still be better off specialising in potatoes.

• Ricardo’s powerful insight was that countries can trade successfully without being the world’s best at anything.

• He called this comparative advantage (being more efficient at one thing than another) as opposed to absolute advantage (being the best at doing something).

• Attempts to carve up markets, for example by imposing quotas, undermines the process of specialisation through trade.

• However, politicians and businesses are protectionist when it suits their interests.

• The most common argument in favour of protection is the infant industry argument, when a new product is being nurtured until its market grows in size to enable it to compete fully with economies of scale.

• There is also a sunset industry, when an industry on its ‘last legs’ is protected in order to support employment and possible regional prosperity.

• In such cases it could be argued that trade barriers actually protect something worth protecting, at least for a limited period of time, until adjustments can be made in markets.

• Due to globalised institutions such as the World Trade Organisation, and successive rounds of tariff reductions, such protectionist measures are rarer these days.

• However, it is probably true to say that every single country in the world actually has a few non-tariff barriers or protectionist ‘measures’ in place.

• Such measures have increased during the last few years due to the credit crunch and its recessionary effects.

• The ‘BRIC’ countries of Brazil, Russia, India and China are arguably the ‘worst’ offenders.

• Their favoured form of ‘measure’ is competitive devaluation, where their governments intervene in money markets to keep the foreign exchange rate of their currency artificially low particularly against the US dollar.

• In Europe, the UK, France, Germany and to some extent Spain, are particularly prone to introduce ‘measures’ in favour of their own ‘pet’ industries.

• The car scrappage scheme of two years ago was intended to favour European car manufacturers by subsidising new cars bought to replace older, allegedly less efficient ones.

• Another form of protection is the subtle use of less stringent regulations on some companies such as under the carbon emissions trading scheme.

• There are strong suspicions that companies regarded as being ‘strategic’ by their governments are given easier emission reduction targets than others, and put in a more favoured position than their foreign competitors.

• Any discussion of international trade has to comment on the relationship between China and the US.

• Nobel Prize winner, Joseph Stiglitz, has identified currency devaluations as a major threat to prosperity.

• Both countries need structural changes, and a rebalancing of their economies, not just re-aligned currencies.

• He describes the process as a “war with no winners”.

• He says that for the global economy to revive, countries need to cooperate rather than devalue their currencies, but at the moment each country is pursuing its own interests.

• The US, worried by unemployment, wants an export-led recovery; China worries that a large appreciation of its currency will cause economic problems at home.

• Stiglitz argues that without international cooperation we will descend back into a world of protectionism which bankrupted trading nations in the 1930s.

• At that time a world recession, even deeper than the one recently experienced, was prolonged by ‘beggar thy neighbour policies’.

• One worrying sign is that this might already be happening in the decision by China to restrict the export of ‘rare earth minerals’ of which it produces 97% of the world supply.

• But, there is a suspicion that this might be a smokescreen to disguise an attempt by China to use the terms of trade to score a ‘win’ over its trading partners.

• These minerals are vital to many products such as mobile phones, TVs, computers and catalytic converters.

• China has announced that for ‘environmental reasons’ it is planning to reduce exports. As their extraction does cause some toxic waste this might be justified.

• International currency exchange rates are not traditionally regarded as a ‘trade barrier’ as such, but there is growing concern that rounds of ‘competitive devaluations’ might have similar results.

• For example, many US politicians believe that the Chinese currency is deliberately undervalued to make Chinese exports even cheaper on overseas markets, and to discourage imports into China.

• This is achieved by the Chinese monetary authorities keeping their currency pegged to the US dollar.

• In due course we might see calls for restrictions on trade with China, or demands for changes in Chinese behaviour, as a condition for China’s participation in international institutions.

• International trade fosters specialisation of production which enhances efficiency in the use of resources.

• Competitive devaluation is a modern form of protectionism.

• There are concerns that unless countries cooperate more a return to the ‘beggar-thy-neighbour’ policies of the 1930s may reappear.

• The United States and China are key countries in respect of future international relations.

• What are the benefits of free trade?

• If these benefits are so persuasive, why do so many countries take part in protectionism?

• Are some forms of trade protection less harmful than others?

• What kind of products can and cannot be traded internationally?

• What are the opportunities and threats created internationally by the ‘e-economy’?