Protectionist Spiral grows

Protectionist Spiral grows
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First Published: Mon, Nov 29 2010. 12 51 PM IST
Updated: Mon, Nov 29 2010. 12 51 PM IST
In many ways, the world today is similar to what it was in the early 1930s. Then, as now, Western economies were in collapse following a boom decade. Deflation and unemployment were rampant. The economic and financial crisis of 2008 produced a global slowdown that resulted in the largest decline in world trade since that time. Trade contracted by 12% in volume terms for the first time in at least 70 years.
Like US President Barack Obama’s election in the midst of a grim reality, Franklin Delano Roosevelt (FDR) rose to power in 1932. The First New Deal that he instituted (1933-35) is in some ways similar to the massive fiscal stimulus that the Obama administration has undertaken. With the stimulus struggling to work, the incumbent FDR administration then, as Obama’s now, was not very popular. FDR was widely expected to last only one term. In a misguided attempt to protect jobs and national output, several protectionist measures were adopted around the world.
The world is on the verge of slipping into the abyss of greater protectionism. The dictionary says protectionism means “fostering domestic industry by protecting them from foreign competition”. Business practice has moved ahead of this 19th century definition to “adopting any means to reverse or reduce external comparative advantage and to bring jobs home”. David Ricardo, the 18th century economist who propounded the theory of comparative advantage, must be turning in his grave.
A key word in this new definition is “any”. The creative use of taxes, duties, withholding, subsidies, directed lending, environmental protectionism and currency management has expanded manifold. In today’s world, this has to be done creatively because many countries have acceded to the free trade regime of the World Trade Organization (WTO), which prohibits increases in frictional costs and has a binding dispute resolution process. Despite the rhetoric in support of free trade and public pledges to continue the agreements of the Doha Round, the US and China are subtly increasing protectionist measures.
The most noise is in the currency market. The US claims China is holding down the valuation of its currency to export cheap goods. In turn, China claims that Americans should focus on their savings rate and not blame the gargantuan US trade deficit on the exchange rate. The two sides of this discussion create the greatest economic imbalance in the world today. The magnitude of quantitative easing in the developed economies—the US, the UK, Japan—makes it inevitable that emerging markets such as China, India, Brazil, Korea and others will make “protectionist” interventions against the free flow of capital. Brazil and Indonesia introduced capital flow taxes last year. Korea may join the party, most likely through a withholding tax on bond flows. India introduced stricter administrative requirements for equity investment in 2007, which it partially reversed in 2008. It has since refrained from specific capital flow provisions, but that day may not be far away.
In addition, there are the less obvious protectionist measures. Imposing export bans on agricultural commodities, as India (sugar, grains) did last year, or as Russia (wheat, flour) did recently, are examples. Making visa procedures more difficult and expensive, as the US did recently with the H-1(B) visa and as India did for low-end Chinese labourers, are other instances. In the US, the various Bills on fiscal stimulus have a “made in the USA” requirement. Bank bailout packages in the UK and France contain clauses to lend in the domestic market.
Europe is no paragon of virtue. The Common Agricultural Policy (CAP) is a massive system of European Union (EU) agricultural subsidies that makes up 40% (€55 billion) of the EU budget each year. This plays havoc on world agricultural prices and is responsible for the belligerent tone taken by the Bric (Brazil, Russia, India and China) countries in the WTO discussion on free markets for agricultural crops. Stealthily, the EU has also adopted environmental protectionism – keeping jobs at home by requiring high environmental standards outside.
And so a murky protectionism has taken hold. With the benefit of hindsight, it is clear that the world is likely to regret this as things return to normal in future. It is not too late to reverse the trend.
Obama is in India this week. He is here to trade jobs for jobs. It would make sense for him to go easy on the “kids from Bangalore and Beijing are out to eat your lunch” rhetoric and to concentrate on jobs in which the US has a comparative advantage (nuclear technology, avionics, aircraft manufacturing, clean technology) and leave the rest to India (IT off-shoring, textiles, contract pharmaceutical manufacturing and so on).
FDR went on to win three more terms as president (term limits were ratified later in 1951). If Obama’s new New Deal imbibes the principal lesson from that era—to abstain from protectionism— presidential history could well repeat itself.
PS: “I played the game to an end with Estella and she beggared me,”says Pip, in Charles Dickens’ Great Expectations, referring to the card game Beggar My Neighbour.
Narayan Ramachandran is an investor and entrepreneur based in Bangalore. He writes on the interaction between society, government and markets. Comments are welcome at narayan@livemint.com
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First Published: Mon, Nov 29 2010. 12 51 PM IST