/ 10 February 2009

Is free trade best way to beat slump?

Staff Photographer
Staff Photographer

History shows that protectionism has seen markets through the toughest times. Larry Elliott asks whether we shouldn’t look at the model if we hope to beat the worst recession since the Thirties

Wildcat strikes at British oil refineries and the international storm created by Barack Obama’s “buy American” clause in his $800-billion reflationary package have brought the cloistered world of trade officials out of the shadows last week.

The backlash against globalisation has prompted fears that the world stands on the brink of a new protectionist era.

French trade unionists have a long tradition of defending their living standards against what they see as unfair competition from countries that frown on organised labour. The protests in Britain in the past few days suggest that the willingness to take industrial action has spread in the face of rising unemployment and what threatens to be the deepest recession since World War II.

Policymakers are clearly alarmed by these developments. Gordon Brown, though expressing sympathy with British workers worried about having their pay and conditions undercut by cheaper foreign workers, has insisted that there must be no retreat from open markets. There was a warning from Brussels earlier this week that any special treatment from the White House for United States steel and manufacturing companies would prompt retaliatory action.

The director general of the World Trade Organisation, Pascal Lamy, said last week that failure to finish the Doha round of trade negotiations would risk a new era of protectionism.

The argument in favour of free trade is that it allows countries to specialise in what they are good at. This leads to greater efficiency, lower prices, higher levels of growth and more jobs. Countries that shut themselves off from the global economy — North Korea, for example — are much poorer than those, such as South Korea, that open their markets. As a result, it is universally accepted in the world of economics that the worst thing that could befall the global economy in its current parlous state would be the sort of tit-for-tat trade war that marked the 1930s. The historical evidence is conclusive: free trade is good, protectionism is bad.

Except that isn’t what the evidence actually shows. Cambridge economist Ha-Joon Chang has demonstrated that no country since the dawning of the modern age has managed to industrialise successfully without protectionism. During the first century of the industrial revolution Britain was one of the world’s most protectionist countries and converted to free trade only in the middle of the 19th century. The US had a 40% manufacturing tariff in its period of rapid expansion at the end of the 19th century. All the post-war Asian tigers — Japan, South Korea, Taiwan and China — have deployed protectionist measures to defend their fledgling industries.

Nor is the lesson of the 1930s quite as clear cut as the free trade camp argues. The US Smoot-Hawley tariff of 1930 was blamed for turning the Wall Street crash of 1929 into capitalism’s worst-ever depression — up to now, at least — but the American Paul Krugman has shown that this was a statistical impossibility and that the immense contraction in the economy between 1929 and 1932 could not have been the result of higher tariffs. Instead, it was the result of a contraction in credit associated with policy errors by the Federal Reserve and the collapse of thousands of banks.

The real lesson of the 1930s is that if you think protectionism is in the offing, it makes sense to raise your barriers first. Lord Skidelsky, the biographer of Maynard Keynes, says that Britain’s economic recovery from the Great Depression was based on three policies — devaluation, cheap money and protectionism. London created a system of “imperial preference” — free trade within the empire but barriers to trade with the rest of the world. Other countries followed suit, abandoning the gold standard so they could devalue and increase tariffs, contributing to the collapse in trade and the prolongation of the slump.

Yet the data shows that Britain had one of the shallowest downturns of all the major industrial nations in the 1930s — a 5% fall in GDP. By contrast, Brown’s devotion to free trade and open markets sits uneasily with Britain’s massive — and growing trade deficit. Policymakers today say that the problem with free trade is that the winners often fail to recognise the benefits they are getting from lower prices, whereas the losers are all too aware when the job they were doing is lost to a textile mill on the other side of the world. The downturn has made not only the actual losers but also millions of potential losers painfully aware of their vulnerability. —