Trade Obstacles will only prolong the Economic Crisis

World Trade

Are we already seeing the beginning of the kind of downward spiral in trade and cross-border investment which turned the 1930s into an economic and political catastrophe?

If so, the outlook is grim indeed, because the globalisation of the past quarter decade has made all our livelihoods much more dependent on international trade and financial flows than in the past. A generation of splitting up and stretching supply chains around the world, of outsourcing and migration, of cross-border direct investment and integration, mean that every person’s living standard depends on what happens in other countries. This has been an astonishing force for growth and the reduction of global poverty for nearly 30 years. But it means the adverse impact of protectionism will be severe.

To see this, consider that in 2006 a fifth of US manufacturing jobs were generated by exports, directly or indirectly (according to the latest annual report of the US Council of Economic Advisers). Workers in these jobs earn up to 18% more than people working for firms not engaged in exports. Other economies are much more dependent on trade than the US, so the threat to living standards from a slump in trade is enormous.

The threat is also imminent. The extent of the integration of most of the world’s economies means 21st century protectionism takes many forms, and we are starting to see most of them. Congress attaches ‘Buy America’ provisions to the government stimulus package. The British government has persuaded oil company Total to give jobs to British workers in order to end wildcat strikes over the employment of Italians. Malaysia’s government has instructed its firms to lay off foreign nationals first. Brazil’s has edged up tariffs on manufactures. Semi-nationalised banks in the US and Europe are pressed to prioritize loans to national companies ahead of foreign ones. Devaluation is welcomed as a useful tool in the policy armoury. As Professor Simon Evenett, of the University of St Gallen, has pointed out, there has been a dramatic increase in the discussion of protectionism in the world’s media, in a reflection of the trend in the policy debate.

The reason for this trend is clearly the slump in exports and cross-border investment during the past few months. No major exporting country has escaped a slump in export volumes since last September. Some of the major emerging economies including Brazil and China have seen a particularly steep decline, given their pivotal role in global supply chains in industries such as apparel and autos. The challenge to policy makers is to halt the downward spiral in demand rather than acting in protectionist ways which will accelerate it.

This is quite a challenge as the scale and complexity of globalisation, the sheer variety of flows of people, goods, and investments across borders, mean protectionism can now take many forms. No longer is it sufficient to prevent tariffs from rising, or to avoid competitive devaluations. Governments need to avoid the many other ways in which they can discriminate against foreign companies and foreign workers – through the regulation of inward investment, through state aid, through tendering processes, through employment laws or health and safety regulations, through instructions to bank managements about lending policies.

It is all too easy to disguise protectionist measures, and all too tempting to engage in them given the political pressures from voters to safeguard their jobs and living standards. Many politicians are continuing to pay lip service to the importance of trade and open economies while advocating measures which will actually undermine the openness which is the only possible engine for restoring growth in the future.

Politicians do of course have to account to their voters. It would be foolish to ignore the political imperatives. However, political leaders have a responsibility to act in the long-term interests of their populations rather than responding to every short-term demand with a quick fix. They also have an opportunity at the forthcoming G20 Summit in London to agree between themselves some principles which will help limit the spread of the virus of protectionism.

At a minimum there are three kinds of measure they must agree. One is support for international as well as domestic lending by banks, including trade credit. International trade and investment flows cannot be sustained without the financial infrastructure which supports them.

The second concerns exchange rates whose movements have been too extreme, and are a source of uncertainty extremely detrimental to trade flows. Over time we will need to see a gradual revaluation of the Chinese currency, as a reduced US balance of payments deficit and reduced Chinese surplus will be needed to rebalance the global economy. Meanwhile, the G7 and G20 should signal their determination to prevent further sharp currency moves.

Finally, and of overwhelming importance, our political leaders must live up to their rhetoric on the need to conclude the Doha Development Round successfully this year. There is little sign so far that any negotiators are taking this pledge seriously, but governments must deliver on it in the coming months. The successful conclusion of the multilateral trade round will be a significant test of leadership, both in its direct impact and in its symbolism. Particular responsibility rests with two countries: the United States and India.

For I am not sure that the lessons of the 1930s have in reality been absorbed by our political leaders. They have poured taxpayer money into bank bailouts, increased spending programs and encouraged central banks to slash interest rates and ‘print money’. But there is no sign that they understand that all the nations of the world economy sink or swim together, and that history’s verdict on their management of this crisis will depend on looking outwards for our lifeboats.

This article first appeared in The Wall Street Journal.