Thursday, March 26, 2009

What can the G20 do about protectionism?

“We have got to be absolutely clear that protectionism offers no solution. It’s the road to ruin. It protects no-one in the long run at all and we are for a free trade world where we remove barriers rather than create barriers, no matter what the temptation is at this particular point in time for individual countries.” Gordon Brown, U.K. Prime Minister, talking about his hopes for the G20 summit.

I have no doubt that the G20 will make a strong statement in opposition to protectionism. After the G20 leaders have agreed that protectionism is the road to ruin and have lined up for the group photo, they will then go home and continue to increase assistance to domestic industries at the expense of imports. The most we can hope for is that the threat of retaliation will prevent the most overt kinds of protectionism that could result in escalation of retaliatory protectionism. If we are lucky the world economy will begin to pick up before protectionism gets out of control.

Why am I pessimistic about the effectiveness of the anti-protectionist pronouncements that seem likely to come out of the G20? It is because decisions by governments about industry assistance are made primarily in response to domestic political pressures and because prevailing perceptions about domestic economic impacts will cause governments to take most notice of the narrow interests that stand to gain from protectionism.

The prevailing perceptions I am writing about include the belief that during a recession it is possible to protect jobs in one industry without any adverse effects elsewhere in the economy, unless there is foreign retaliation. It is easy to see why this is economic nonsense. Import restrictions cause consumers to buy higher-priced domestic production rather than imports – they work in the same way as a tax on consumption of a good that is used to finance a subsidy to producers. The result is that consumers have less income to spend on other goods. Jobs are saved in one industry at the expense of jobs elsewhere in the economy.

Some readers might be thinking that this reasoning doesn’t apply to industry assistance that is funded from government spending because the increased spending just goes to increase the fiscal deficit and government debt. Some government leaders who increase budgetary assistance to industry might even think they have reason to expect to be patted on the head by leaders of other governments for doing something to stimulate the world economy. The truth is, however, that such covert protectionism is unlikely to even stimulate the domestic economy since private investors are likely to be forced to pay higher interest rates in order to fund their investments, and domestic taxpayers are likely to increase precautionary savings in anticipation of having to pay higher taxes in the years ahead.

Is there anything that the G20 countries could do that would help governments to deal with the domestic political pressures that result in increased protection during recessions? The least they could do is to compare notes about how they cope with such pressures in their own countries. Australia’s prime minister, Kevin Rudd, is probably too modest to trumpet the success of the Hawke government in dealing with protectionism in the 1980s with the help of domestic transparency arrangements. It might be possible, however, for leaders of other governments who have an interest in this matter to prevail upon our Kevin to provide them with some helpful information on this topic.

Readers who wonder what I am talking about might be interested in this.


Vance Christensen said...

Until government realizes it is a burden on any economy than a stimulative entity, we will continue to experience longer recessions, deeper depressions, and lost productivity.

I am not confident the State can change its ways. It's natural for human beings to setup artificial means of control. Not only do most economists not understand economics, but the politicians certainly don't understand the role of government. With ample ambition on Capitol Hill and in parliaments around the world, we will continue on the path of economic destruction. Freedom found in capitalism is the only means by which we can unlock the full potential of our capacity. The only barrier to that end is the State.

Winton Bates said...

I agree with you about the importance of economic freedom, but one of the odd things I have observed over the last 40 years or so is that most politicians would actually like to do things that would improve the well-being of the people they represent. Looking around the world and over time, there is a huge variation in how successful politicians have been in following policies that have raised living standards.

Another odd thing I have observed is that some governments have been able to behave in a fairly market-friendly manner despite having apparent ideological attachments to social democratic ideals.

Outcomes seem to depend to a huge extent on the ability of governments to focus on economy-wide impacts of policies rather than to follow the populist path of pandering to narrow interest groups. I think processes for policy development (rules of the game) are very important.