The protectionism boogeyman

In a thoughtful column in yesterday’s Financial Times, Gideon Rachman laments the collapse of the Davos Consensus on globalization by noting that the two most important speeches made last week were President Obama’s State of the Union address and a campaign speech by leading French presidential candidate Francois Hollande rather than any of the forgettable mumblings in Davos.

The problem that all three parties were addressing is that of high unemployment, falling living standards, and lost wealth in the western world in the context of globalization. Former EU Trade Commissioner Peter Mandelson spoke for the Davos consensus when he said that the job of politicians is to convince the public that globalization is good even when it is blamed for rising unemployment and falling living standards.

In contrast, Obama and Hollande spoke of improving the lot of the middle class, broadening the social safety net, asking the rich to pay their fair share in taxes, better regulating and constraining the financial industry, repatriating manufacturing and reindustrializing their domestic economies, and better enforcing the rules of the World Trade Organization and of other free trade agreements.  Hollande even spoke of "reasserting the sovereignty of the Republic", presumably against that of the mostly undemocratic multi-national institutions. Thus, while the solution of the global establishment as represented by the apostles of Davos is more of the same globalization that has contributed greatly to the present crisis and western misery, that of the leading candidates in the two most important western elections this year is to question some of the key tenets of globalization.

Now here is a key point. As reasonable as it may sound to question something that appears not to be working, Rachman, speaking for the establishment, warns that Obama and Hollande’s proposals implicitly protectionist and thus dangerous. So once again the bogeyman of "protectionism" is rolled out to prevent any questioning of or change in the status quo conventional wisdom that free trade and globalization are always and everywhere a win-win proposition that inevitably maximizes wealth creation and welfare.

There are a number of problems with this somewhat knee jerk orthodox establishment reaction. For one thing, it’s not at all clear why trying to enforce trade laws and globalization agreements is protectionist. It has become a kind of Pavlovian dog reaction on the part of the establishment media to label as protectionist any U.S. or other western concern for enforcement of trade rules while overlooking chronic rules infractions by a wide variety of global players. If Obama speaks of enforcement of the rules, he’s labeled a dangerous protectionist, while no editorials or columns mention the conditioning of market access on technology and production transfer that is practiced by many countries, that is in violation of WTO rules, and that gives rise to Obama’s call for rules enforcement.

Everyone seems to agree that free trade requires rules, otherwise they would not engage in the long hours of negotiation necessary to establish the rules. If all agree that the rules are necessary, how can it be protectionist to call for their enforcement? We must remember that non-compliance with the rules is usually much more protectionist than any enforcement effort. Indeed, I would argue that strict enforcement is far more supportive of free trade than looking at infractions with a blind eye.

A second, more fundamental question, is why anyone thinks that free trade and globalization are always win-win. In the first place, free trade and globalization are not the same thing. Globalization involves capital flows, direct foreign investment, and technology transfers that are not usually involved in plain old trade transactions. Economic theory holds that free trade is win-win, but only under certain restrictive assumptions such as that all markets are perfectly competitive, that exchange rates are fixed, that there is full utilization of resources, that there are no economies of scale,  and that there are no cross border flows of capital, technology, or labor. Obviously, those assumptions hold only in very few instances in modern trade.

Turning to globalization, there is even less of a theoretical basis for arguing that it is always a win-win proposition, and that argument is usually made without making a full accounting of the costs of globalization such as those affecting the environment, dislocation of workers, capital investment losses, and skills learning. The truth is that globalization may or may not be a win-win proposition depending on a wide variety of circumstances.

The final question is why economic orthodoxy condemns protection as always the most evil of phenomena. On the one hand, recent research by Berkeley’s Barry Eichengreen and Dartmouth’s Doug Irwin confirms that the Smoot-Hawley tariff frequently blamed as the prime cause of the Great Depression was not. I think most observers would agree that the mercantilist and state capitalist economies such as those of China, Japan, Germany, Korea, Brazil, Taiwan, and Russia all engage in a significant degree of protectionism and are also the ones presently enjoying the most success. As one observer has put it: "raw protectionism is the breakfast of champions." Well, maybe that’s a little strong, but it certainly does look as if the economies with relatively more protection are doing better than the ones with relatively less.

Certainly, it cannot be denied that the mercantilists have gained the most power over the years. Countries with current account surpluses and large reserve holdings are the ones that increasingly call the tune in the global power game. Creditors are almost always in a stronger position than debtors.

In view of that maybe Obama and Hollande are simply thinking that if they "can’t like em maybe they should join em.