Story Of The Week

Trade Protectionism in the 21st Century

Written by: Dr. S P Sharma
Chief Economist and Principal Director of Research, PHDCCI

Of late, the discourse against globalization has been shifting away from strengthening domestic industry through necessary economic reforms towards shielding it from global competition. This is not a very good signal for the global economy. As such our world is optimistic about global growth in 2018 and beyond. While economic fundamentals look good, risks from global politics continue to remain on a rise. In particular, the issue of trade protectionism has taken center stage.

Early this year, the U.S introduced tariffs on imports of steel, aluminum and various Chinese goods. The objective behind this move was to protect America’s “national security” and to sanction China’s “unfair trade practices.” India and other countries, including US allies like Canada and the EU, were also not spared from the increased tariffs. As was expected, the affected countries quickly hit back in response to these measures, coming out with retaliatory tariffs against U.S goods. This tit-for-tat escalation in trade measures has now culminated into a situation termed as “trade war.”

It is worthwhile to note that both China and the U.S together account for 23% of world trade standing at USD 35 trillion in 2017. Therefore, it becomes necessary to understand the ripple effects on the world economy of the U.S. move to protecting its domestic industry in the name of employment.

The multilateral trading framework that is operational throughout the world is based on the concept that protectionism hurts the level of economic advancement prevailing amongst the countries which in turn affects their overall prosperity. However, usually during periods of slow economic growth, countries have been resorting to trade protectionist measures by using them as a tool to safeguard domestic production and reduce the level of imports.

Trade wars between countries are not a fresh phenomenon. There have been historical incidences in the past too and the resulting consequences have been damaging for global prosperity. One such famous episode of aggressive tariff imposition is the U.S Smoot-Hawley Act wherein literature review suggests that the act raised average U.S. tariffs to around 45%.

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Source : Google.com

Subsequently, during the Great Depression of the 1930s, many other countries devised trade barriers to shield their economies from competition and hence, aggravated the deep recession that engulfed the world economy at that time. The resulting contraction in world trade and the downward economic spiral that accompanied has, therefore, been raised as a regular warning regarding the economic con­sequences of practicing protectionism.

It was this bitter experience of the 1930s and the damaging effects of World War II that economists have largely favored the notion of globalization. Globalization is based on the principle of global free movement of goods, services, and people as well as capital. This consensus led primarily by the U.S, pushed for the foundation of Bretton Woods institutions and the current international trading system. The General Agreement on Tariffs and Trade (GATT) came into force and then the movement intensified later with the implementation of bilateral and regional free trade zones and also the creation of the World Trade Organization (WTO).

The benefits arising from globalization can be enormous. However, over the years the walls have been blurring to include a range of definitions so that the results coming out have been both positive and negative. Nonetheless, promotion of free trade has worked in favor of increasing the level of global GDP in the past decades. World GDP at current prices has increased significantly from USD 11 trillion in 1980 to around USD 79 trillion in 2017 and is estimated to reach USD 87 trillion in 2018.

The benefits that arise from a more liberalized ecosystem are that imports increase competition for domestic businesses and raise the variety as well as the quality of the intermediate products available to businesses. Certain protectionist measures may occasionally have had a positive impact; however, fundamentals of the economic theory say that protectionism is rarely a good idea to pursue. It could lead to higher consumer prices, resulting in inflation and hence higher interest rates. Moreover, protectionism has a negative effect on an economy’s productivity by discouraging competition, specialization, innovation, and knowledge transfer.

Undoubtedly, there has been a widespread decline in tariffs on imports, and a drop in other types of trade barriers as well. However, by the time we reached 2000, the globalization movement which had attained full speed started to slowly wither out. In particular, the 2008 global financial crisis brought in fears of a potential worldwide protectionist spiral and also worries of a shift towards new forms of protectionism although traditional trade barriers are still the most predominant policy instruments used.

Hence, the economic problems that afflicted our world post the crisis, led to the normalization of the free trade enthusiasm in many economies. The crisis resulted in prompting many governments across the world to put in place stimulating policies that were more nationally focused. It is now difficult to have new free trade treaties adopted, either because of a lack of interest on the part of government authorities or due to the political difficulties involved in getting them approved.

It may be asserted that a diminished US-China trade engagement could yield positive results for India from a trade perspective. However, no one wins in a trade war since the end result is a diminishing international trade order. Trade war, therefore, is a side effect of trade protectionism; nothing but a reflection of disequilibrium in the thought processes of various nations.

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Source: washingtonexaminer.com

The economic meaning of U.S. blocking imports from China of critical inputs like steel and aluminum is that the two sectors in China will be facing problems. Since the two inputs are used in making products within China as well, which are in turn manufactured by importing raw materials from South East Asian economies like ASEAN, Japan, Korea, etc implies that the demand for such materials will go down resulting in the lower level of economic activity in the region. As a result, demand by these economies for US products is likely to decrease.

To sum up, it seems that what began as protecting jobs in the US by way of raising tariffs on China and other countries, would lead to lower demand for US products in the rest of the world, creating unemployment. Going ahead, it is upon the world community as a whole to make the multilateral order work by strengthening the rules to the benefit of all. For this, we all have to be hopeful that more Free Trade Agreements are signed between the countries in the coming times to promote free trade in the world ecosystem.

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