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THE NUTS AND BOLTS COME APART
Mar 26th 2009
As global demand contracts, trade is slumping and protectionism rising
COMPARISONS to the Depression feature in almost every discussion of the
global economic crisis. In world trade, such parallels are especially
chilling. Trade declined alarmingly in the early 1930s as global demand
imploded, prices collapsed and governments embarked on a destructive,
protectionist spiral of higher tariffs and retaliation.
Trade is contracting again, at a rate unmatched in the post-war period.
This week the World Trade Organisation (WTO) predicted that the volume
of global merchandise trade would shrink by 9% this year. This will be
the first fall in trade flows since 1982. Between 1990 and 2006 trade
volumes grew by more than 6% a year, easily outstripping the growth
rate of world output, which was about 3% (see chart 1). Now the global
economic machine has gone into reverse: output is declining and trade
is tumbling at a faster pace. The turmoil has shaken commerce in goods
of all sorts, bought and sold by rich and poor countries alike.
It is too soon to talk of a new protectionist spiral. Nevertheless,
errors of policy risk making a bad thing worse--despite politicians'
promises to keep markets open. When they met in November, the leaders
of the G20 rich and emerging economies declared that they would eschew
protectionism and will doubtless do so again when they meet on April
2nd. But this pledge has not been honoured. According to the World
Bank, 17 members of the group have taken a total of 47
trade-restricting steps since November.
Modern protectionism is more subtle and varied than the 1930s version.
In the Depression tariffs were the weapon of choice. America's
Smoot-Hawley act, passed in 1930, increased nearly 900 American import
duties--which were already high by today's standards--and provoked
widespread retaliation from America's trading partners. A few tariffs
have been raised this time, but tighter licensing requirements, import
bans and anti-dumping (imposing extra duties on goods supposedly dumped
at below cost by exporters) have also been used. Rich countries have
included discriminatory procurement provisions in their fiscal-stimulus
bills and offered subsidies to ailing national industries. These days,
protectionism comes in 57 varieties.
There are good reasons for thinking that the world has less to fear
from protectionism than in the past. International agreements to limit
tariffs, built over the post-war decades, are a safeguard against
all-out tariff wars. The growth of global supply chains, which have
bound national economies together tightly, have made it more difficult
for governments to increase tariffs without harming producers in their
own countries.
But these defences may not be strong enough. Multilateral agreements
provide little insurance against domestic subsidies, fiercer use of
anti-dumping or the other forms of creeping protection. Most countries
are able to raise tariffs, because their applied rates are below the
maximum allowed by their WTO commitments. They may choose to do so
despite the possible disruption to global supply chains. And because
global sourcing amplifies the effect of tariff rises, even action that
is permissible under WTO rules could cause a lot of damage. The subtler
variants of protection may be similarly disruptive.
THE GEARS OF GLOBALISATION
The immediate cause of shrinking trade is plain: global recession means
a collapse in demand. The credit crunch adds an additional squeeze,
thanks to an estimated shortfall of $100 billion in trade finance,
which lubricates 90% of world trade.
Just as striking as the speed of the downturn in trade is its
indiscriminate nature. The World Bank has January trade data for 45
countries (available figures for G20 countries are shown in chart 2).
These are values, expressed in American dollars, and so have been
depressed not only by lower volumes but also by falling prices and a
stronger dollar. The exports of 37 of these 45 countries were more than
a quarter lower than in January 2008. Countries as diverse as Ecuador,
France, Indonesia, the Philippines and South Africa saw exports drop by
30% or more. Commodity exporters, such as Argentina, have suffered with
sellers of sophisticated manufactures, such as Germany and Japan.
Kei-Mu Yi, an economist at the Federal Reserve Bank of Philadelphia,
argues that trade has fallen so fast and so uniformly around the world
largely because of the rise of "vertical specialisation"
supply chains. This contributed to trade's rapid expansion in recent
decades. Now it is adding to the rate of shrinkage. When David Ricardo
argued in the early 19th century that comparative advantage was the
basis of trade, he conceived of countries specialising in products,
like wine or cloth. But Mr Yi points out that countries now specialise
not so much in final products as in steps in the process of production.
Trade grows much faster in a world with global sourcing than in a world
of trade in finished goods because components and part-finished items
have to cross borders several times. The trade figures are also boosted
by the practice of measuring the gross value of imports and exports
rather than their net value. For example, a tractor made in America
would once have been made from American steel and parts; it would have
touched the trade data only if it was exported. Now, it may contain
steel from India, and be stamped and pressed in Mexico, before being
sold abroad. As a result, changes in demand in one country now affect
not just the domestic economy but also the trade flows and economies of
several countries.
This mechanism can be seen at work in recent data--for instance, says
Mr Yi, in American automotive-trade figures for the last three months
of 2008. Imports from everywhere fell by about 20%. On the export side,
sales to America's partners in the North American Free Trade Agreement
(NAFTA) fell by 20% whereas those to non-NAFTA countries rose slightly.
This, he argues, is because three-quarters of exports to non-NAFTA
countries consist of finished vehicles, whereas 60% of exports to NAFTA
partners consist of parts and components, most of which return to the
United States embodied in imported vehicles. So American exports to
other NAFTA countries are to a large extent determined by America's own
demand for cars.
By making trade flows more sensitive to falls in output, vertical
specialisation may provide some insurance against widespread
protectionism. Manufacturers that rely on imported inputs may resist
higher tariffs because they push up the prices of those inputs, making
domestic industry less competitive.
Governments using tariffs as trade weapons now have to calculate the
consequences far more carefully. This is borne out, for example, by
Mexico's response this month to the suspension by America of a NAFTA
programme that allowed some Mexican truckers to carry goods north of
the border. Mexico raised some tariffs, but by less than NAFTA rules
allowed, and chose the goods carefully in order to limit the damage to
its own industries.
Nevertheless, there is plenty of evidence that developing countries, at
least, continue to use tariffs extensively. In the World Bank's study,
tariff increases accounted for half of the protective measures by these
countries. Ecuador raised duties on 600 goods. Russia increased them on
used cars. India put them up on some kinds of steel. Developing
countries have more scope for raising tariffs without breaking WTO
rules than richer ones do, because the gap between their applied rates
and the ceilings they agreed to is greater than for developed countries.
When governments do impose tariffs, vertical supply chains amplify
their effects. Because tariffs are typically levied on the gross value
crossing the border (with some exceptions, such as exports from Mexican
MAQUILADORAS)
up--with global supply chains than without.
But there is another, more subtle reason to worry about even small
rises in tariffs. Theoretical models that incorporate vertical
specialisation find that it takes off only when tariffs fall below a
threshold level. Once this happens, however, trade explodes, so that a
slight lowering of trade barriers can cause a huge increase in trade.
By the same token, if tariffs rose above a certain point--which might
be below the maximum agreed on at the WTO--global supply chains would
disintegrate. Trade would drop even more steeply than it has in recent
months.
That said, supply chains need not snap so easily. Even if tariffs go
up, other costs that determine the viability of supply chains may go
down: the price of oil (and hence the cost of transport) has fallen a
long way in the past year. Firms have invested a lot in their supply
chains and will be loth to abandon them. And if global supply chains do
survive, vertical specialisation could help trade recover speedily when
demand returns.
Although increased tariffs are a cause for concern, they are far from
the only form of protection being used in this crisis. Two-thirds of
the trade-restricting measures documented by the World Bank are
non-tariff barriers of various kinds. As with tariffs, developing
countries are the principal wielders of these weapons.
Indonesia has specified that certain categories of goods, such as
clothes, shoes and toys, may be imported through only five ports.
Argentina has imposed discretionary licensing requirements on car
parts, textiles, televisions, toys, shoes and leather goods; licences
for all these used to be granted automatically. Some countries have
imposed outright import bans, often justified by a tightening of safety
rules or by environmental concerns. For example, China has stopped
imports of a wide range of European food and drink, including Irish
pork, Italian brandy and Spanish dairy products. The Indian government
has banned Chinese toys.
In addition, anti-dumping is on the increase. The number of
anti-dumping cases initiated at the WTO had been declining, but it
started to pick up in the second half of 2007. The data for 2008 are
not yet complete but Chad Bown, an economist at Brandeis University,
estimates that the number was 31% higher than in the previous year. The
number of cases ending with extra duties went up by 20%. India was the
biggest initiator of anti-dumping action, and America and the European
Union imposed duties most frequently.
Rich countries' weapon of choice so far is neither tariffs nor
non-tariff barriers to imports. They have been keen users instead of
subsidies to troubled domestic industries, particularly carmakers. Some
economists, such as Gene Grossman, of Princeton University, cite this
as evidence that global sourcing has changed the political economy of
protection. The American automotive industry no longer lobbies for
direct protection, as it used to, because it imports much of its
value-added and competes with foreign firms that assemble their cars in
America. Carmakers now prefer explicit subsidies, and the world is
replete with examples. Besides America, Argentina, Australia, Brazil,
Britain, Canada, China, France, Germany, Italy and Sweden have all also
provided direct or indirect subsidies to carmakers. The World Bank
reckons that proposed subsidies for the car industry amount to $48
billion. Nearly 90% of this is in rich countries, where it can easily
be slipped into budgetary packages to stimulate demand.
The worry about such subsidies is that they could cause production to
switch from more efficient plants (eg, in central and eastern Europe)
to less efficient ones in rich countries with deep pockets (eg, in
western Europe). Whether the location of output is shifting is not yet
clear, but politicians plainly hope it will. On March 19th Luc Chatel,
the French industry minister, boasted that Renault's plans to create
400 jobs at a factory near Paris by "repatriating" some production from
Slovenia was the result of government aid. Renault has denied this,
saying that it was at full capacity in Slovenia.
There are some international rules to prevent distorting subsidies. The
EU has regulations to limit state aid, and is looking into its members'
assistance to carmakers. Gary Hufbauer, of the Peterson Institute for
International Economics in Washington, DC, argues that American
subsidies transgress WTO norms.
HELPFUL AMBIGUITY
However, WTO action against subsidies is not straightforward. To
complain successfully, a country has to show that a subsidy meets
several criteria. Then there is a pots-and-kettles problem: having
subsidies of your own does not stop you from challenging someone
else's, but if you pick a fight they may have a go at yours. This
uncertainty and ambiguity only adds to subsidies' attraction.
Governments can aid their carmakers and at the same time criticise
others for their protectionist ways.
Protectionist urges are also being bolstered by countries' seeming
inability to co-ordinate their fiscal stimulus programmes. Some
countries have been reluctant to work the budgetary pump for fear that
their extra demand will leak abroad to the benefit of foreigners. To
stop the seepage, some governments have inserted discriminatory
conditions into their fiscal programmes, the prime example being the
"Buy American" procurement rules. These were weakened after protests
and threats of retaliation from abroad, but not before the prospects
for global co-operation had been dented. Greater co-ordination of
fiscal expansion would ease governments' worries about leakage, because
everyone else would be leaking too: all would gain from each other's
spending.
What should world leaders do to stop protection fraying the threads
that tie the world economy together? The pious declaration at the
previous G20 meeting has had little effect. There is a risk that
another such promise on April 2nd will prove to be just as empty. The
difficulty lies in devising something comprehensive and detailed enough
to address the variety of protectionist measures that are being
deployed in the crisis, and doing it quickly enough to maintain open
trade.
Many argue that the most important thing for world leaders to do is to
pledge a quick completion of the Doha round of trade talks, which
stalled for the umpteenth time last summer. By reducing tariff
ceilings, this would place tighter limits on countries' ability to
increase tariffs. It would also ban export subsidies in agriculture,
which are being used with greater vigour, especially as prices of farm
goods fall. The EU, for example, has announced new export subsidies for
butter, cheese and milk powder. Most important, completing Doha would
be the clearest and most tangible evidence possible of a commitment to
consolidating and building on the gains from more open trade secured in
successive rounds since the second world war.
Some economists disagree. Aaditya Mattoo, of the World Bank, and Arvind
Subramanian, of the Peterson Institute, argue that the Doha round is
too ambitious given the state of the world economy, because it seeks to
open markets for rich countries' manufactured goods just when the
politics are against it. At the same time, they point out that Doha
would not restrict the use of some non-tariff measures causing most
concern, such as the Buy American provisions or subsidies for failing
industries. Messrs Mattoo and Subramanian suggest a new "crisis round"
of world trade talks. In the first instance, WTO members could commit
themselves to a standstill on all forms of protectionism.
Several other economists have also proposed a standstill. However,
Messrs Mattoo and Subramanian suggest that in order to give governments
a political reason to agree to this, they should also be allowed to
postpone further liberalisation for the duration of the crisis. They
would then embark on a new round instead of Doha, which would address
the forms of protection that now look most pressing.
But the appetite for starting yet another series of talks is likely to
be limited. Even if the crisis round's agenda were more realistic than
Doha's (which isn't obvious), there would be no guarantee that it could
be concluded quickly enough to stop the bleeding in global trade.
Whatever they think about Doha or about the idea of a crisis round,
most economists will agree that a simple promise to resist
protectionism will not suffice. Some thing more specific is needed. A
good start would be for governments, beginning with the leaders of the
G20, to draw up a comprehensive list of protectionist measures that
goes beyond tariffs and export subsidies. They could then agree to go
no further with these than they have already.
Next, an agreement on co-ordinating fiscal policy would go a long way
towards making such a standstill commitment credible, because it would
alleviate worries about leakages abroad. Finally, empowering the WTO to
name those who break the standstill would help to underpin it. The
threat of embarrassment may make some countries think twice.
During the Depression, the volume of world trade shrank by a quarter.
Nothing like that has been seen or forecast so far. Yet one lesson from
the worldwide economic distress of three-quarters of a century ago is
that once trade barriers come up, they take years of negotiation to
dismantle. Preventing protectionism from getting worse is preferable to
having to repair the damage afterwards. And even if a full-blown trade
war can be ruled out, death by a thousand cuts cannot. The costs of
myriad piecemeal measures could still add up to damaging protectionism.
And when demand does eventually revive, if the world economy is
supported by an open system of trade, it will recover all the faster.
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