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By Philippe Legrain 1 COMMENT

The failures of global finance have brought the world economy to its knees, threatening a re-run of the Great Depression of the 1930s. Such a terrible outcome is much more likely if policymakers follow Ha-Joon Chang’s suggestion that the world needs a dose of protectionism to see it through these troubled times.

Around the world, we are witnessing the devastating impact of globalisation going into reverse. What was once a virtuous circle of rising trade and booming economic growth has become a vicious spiral of collapsing demand and plunging exports. The question is: how to break this spiral? The answer, in my view, is coordinated government action to boost global demand, combining large fiscal stimulus packages, unconventional monetary policy measures, and the nationalisation and restructuring of zombie banks that are dragging the economy down with them. Chang, in contrast, favours limited protectionism—in effect, a tax on imports.

This should ring alarm bells among people who may be tempted by the siren song of protectionism. Most governments are scrambling to boost spending and /cut/ taxes to stimulate demand. David Cameron’s Conservatives oppose such a fiscal stimulus. Chang goes one step further: he is proposing a (selective) tax hike instead. The immediate impact would be to reduce people’s purchasing power in a highly regressive way. And since Chang proposes that all governments agree to raise their import taxes, demand would be dealt a further knock by the fall in demand for our exports. Higher taxes and lower exports as a cure for the global recession? This is the economics of the madhouse.

Chang is surely aware of this. After all, even he concedes that an all-out trade war would be a bad thing. But the difference between limited protectionism and a trade war is a matter of degree: the former would involve fewer casualties, for sure, but it would not lead to economic resurrection. And history shows that limited protectionism is often a precursor to much larger conflicts.

Chang claims that rising protectionism in the 1930s was not as harmful as is often claimed. It is true that trade collapsed for several reasons, including falling demand. But protectionism greatly amplified the damage. According to a study by Jakob Madsen of Monash University (Trade Barriers and the Collapse of World Trade During the Great Depression), world trade declined 14% in inflation-adjusted terms between 1929 and 1932 due to declining incomes, 8% because of policy-induced tariff increases, 5% due to deflation-induced tariff increases (when prices are falling, a tariff of, say, £1 per item rises in real terms), and a further 6% because of the imposition of non-tariff barriers. So, most of the collapse in trade was due to rising protectionism rather than falling demand.

Nor did protectionism save jobs. Research by Doug Irwin of Dartmouth College, the leading US trade historian, concludes that “The Smoot-Hawley tariff of 1930, for example, significantly reduced imports but failed to create jobs overall because exports fell almost one-for-one with imports, resulting in employment losses in those industries.”

Clearly, then, the costs of protectionism are large. Yet Chang claims that “temporary” protectionism would have a big benefit: it would provide breathing space for companies and workers to reinvent themselves. But that too is dubious. Protectionism does not provide the right incentives for businesses and workers to adapt. Companies that have a captive local market tend to milk it, rather than seeking out more competitive markets overseas—especially if they are prevented from doing so by others’ protectionism. And while protectionism may start off as a “temporary” response to the crisis, companies that benefit from it have every incentive to find new reasons to maintain it, and to devote their energies to lobbying politicians to that end. Just look at Europe’s Common Agricultural Policy, which was originally designed to prevent Europeans starving. The last thing we need is a CAP writ-large.

Protectionism would obstruct the world economy from adjusting, rather than encouraging it. There is, for instance, huge overcapacity in the US and European car industries. If each country acts to prop up their carmakers, none will thrive. Only if the least efficient shrink can the carmarkers that produce the cars people actually want to buy thrive. Chang’s prescription is also bizarre considering his main focus is aiding developing countries. If the EU keeps out foreign cars, India’s Tata Motors and his native South Korea’s Hyundai, Daewoo and Kia will suffer.

In Britain’s case, advocating protectionism is particularly perverse. One big reason why the manufacturing sector has shrunk so much in recent years is the pound’s prolonged overvaluation. Now that the pound has collapsed, UK-based exporters, not least its remaining manufacturers, have received a timely boost that will make them more competitive when the global economy recovers. An increase in global protectionism would close off their future export markets.

The real help that companies need to tide them through the crisis is not protectionism but access to finance and broad measures to stimulate demand. These would also boost employment, especially if combined with cuts in payroll taxes and increased help for workers to retrain and find new jobs.

Posted 25 Mar 2009 in Published articles
  1. Phillipe, I believe you are misunderstanding exactly what Chang proposes in his article. The debate over protectionism and free trade always seems to have one side creating a straw man of the other which is a shame.
    You make the assumption that he suggest that all governments agree to raise their import taxes, he does not suggest any such thing. Protectionist measures come in various forms, tariffs being just one of a large number of different policies. Tariffs would indeed be largely counterproductive in most developed countries since many of their jobs depend heavily on imported goods. National governments are aware of this and would realise the folly of such a move.
    The real argument, one that Chang doesn’t make especially clear in this article is about a pragmatic application of protectionist measures by national governments in order to:
    A) Promote sustainable future economic development
    B) Preserve viable sectors of the economy going through tough times
    C) Actively promote the restructuring of the economy
    D) Minimise the social cost of economic restructuring
    Protectionist measures can assist in meeting these goals, for developing countries tariffs are often a very effective way of raising revenue and can be a useful tool for raising funds in order to encourage development. For developed countries such measures are not pragmatic, but subsidies and low interest loans can be used to promote sectors seen as essential for future growth while causing a minimum of distortion to international trade.
    Where I feel the true difference between yourself and those of us who call ourselves “protectionist” lie is in the role of the state. The solutions you propose are broad measures and I personally do not believe these will be sufficient, I believe (and suspect Chang would agree) that any economic stimulus should be far more targeted with a view to promoting specific sectors of the economy.

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