Global Trends by Martin Khor

Monday 9 February 2009

Protectionism on the rise

Western countries are increasingly resorting to protectionist measures such as “buy local” clauses in government spending and massive subsidies for their failed companies.  Developing countries may be the ultimate victims.

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As the recession deepens in the Western countries, many of them are resorting to protectionism. This adds to the problems in developing countries that are already facing the effects of the global economic turmoil.

Protectionism is the policy of protecting the markets, industries or jobs of one’s own country, usually by restricting the entry of products or services from other countries.

It can take, and is taking, many forms.  The most recognizable protectionist method is to restrict imports by imposing a tariff, a ban or a quota.  There are also non-tariff trade barriers, such as imposing anti-dumping measures or using safety standards as an excuse to block imports.

Protectionism can also take the form of requiring (or giving incentives to) government agencies or companies to make use of locally produced goods and services, thereby putting foreign products at a disadvantage.

Then there are the subsidies that governments give to industries or financial institutions, either to keep bankrupt companies afloat or to strengthen viable ones.  Without these state aids, they may fall or be taken over, including by foreigners. 

If enough subsidies are given, they may even be able to export, and at prices below their cost of production, as is taking place in agricultural goods like rice, wheat or chicken coming from the United States and Europe.

Most economists are against protectionism, partly because it is bad overall for the country practicing it (the costs of consumer goods or production inputs increase as a negative effect, that may outweigh the benefits of increased local business and jobs) but mainly because it will invite retaliation from affected countries, lead to “trade wars” and reduce global trade overall, to the detriment of all parties.

The protectionist measures taken by the United States in the 1930s are said to have triggered trade wars and to have worsened the Great Depression.

New forms of protection are now emerging in the global crisis.  The most notable is the “Buy American” clause in the US$800-plus billion stimulus package now being negotiated in the US Congress.

In the House of Representatives version of the Bill, increased government spending on steel and some manufactured products will only be for made-in-America products. 

After protests from political leaders in Canada and many European countries, this clause is to be watered down (that it will be in line with international law) in the Senate version, but is likely to remain, thus violating the spirit if not the letter of the non-protection principle.

France is another country where blatantly protectionist policies are on the rise.  According to a Financial Times report on 3 February, French President Nicolas Sarkozy wants French car companies Peugeot and Renault to commit to buy specific volumes of parts and services from local suppliers in return for soft loans and loan guarantees.

Last Friday he also called on the two car companies to close their factories in eastern Europe and move production back to France, sparking a protest from the Czech Republic.

The biggest protectionist measures however are in the area of subsidies.  Until the current crisis the most notorious subsidies were in agriculture, with developed countries providing over US$300 billion in state aid to farmers and food companies, and in high prices paid by consumers. 

This has enabled otherwise uncompetitive Western farm products to flood international markets, at the expense of developing countries’ farmers.

The subsidy phenomenon is now rising in the industrial and services sectors.  In industry, most subsidies are banned by rules of the World Trade Organisation.  Recently, however, the United States Congress approved a US$17.4 billion aid package to two crisis-hit car companies Chrysler and General Motors.

Some European leaders originally threatened to take action against this US move, but their countries are instead now joining the US to also give subsidies to save their car companies. 

Sweden is providing US$3.4 billion to Volvo and Saab in loan guarantees and support for research and development, France has promised US$7.8 billion in loans and loan guarantees to its car companies and the German finance minister said it is “fatal” not to support German auto companies when the US is giving its own firms billions of dollars in aid.   

Although protectionism is spreading in the manufacturing sector, it has arrived with incredible force in services, where the United Stares and European governments have doled out more than US$1 trillion in various types of aid to banks, insurance companies and other financial institutions, such as house-mortgage companies.

Without these massive injections of equity, loans and loan guarantees, giant companies such as Citigroup and AIG in the US, UBS in Switzerland and Royal Bank of Scotland in the United Kingdom would have gone under.

Developing countries are at a disadvantage because they do not have the same amounts of public funds to bail out their troubled manufacturing companies or financial institutions.

As the recession worsens, more firms and banks in the developing countries will get into difficulties.  Not only will their business and very existence be threatened, their markets or equity could even ironically be taken over by giant foreign companies which are massively subsidized by their own governments.

The US was first off the mark with the new protectionism.  Europe followed, taking the principle “if you can’t beat them, join them.”   Many developing countries can neither beat them nor join them, simply because they lack the large funds needed to play this subsidy game.