Protecting Open Markets

by Robert Z. Lawrence, Peterson Institute for International Economics

Op-ed in VoxEU.org
December 4, 2008

© VoxEU.org


The world economy is in the greatest jeopardy since the 1930s. The crisis has spread through global financial markets like a virulent pandemic, leaving no country unaffected. Plummeting freight rates and massive inventory buildups on the docks attest that the crisis is also spreading through global markets for goods and services. But the worst is yet to come because the real economy will inevitably fall more deeply into recession.

If there were still need for evidence of global economic interdependence, it was surely provided by the way no country has been spared. The idea that growth in developing countries could be sustained despite the slump in advanced countries—decoupling—has proven misguided. Today the choice is clear: Countries hang together or they hang separately.

Financial policymakers are…trying with impressive ingenuity to avoid the mistakes of their historical counterparts …. It remains to be seen, however, whether trade policymakers can do likewise.

Are we going to repeat the Great Depression? Unlike the 1930s, fiscal policymakers are fortunately moving speedily and decisively to run larger budget deficits. Financial policymakers are also trying with impressive ingenuity to avoid the mistakes of their historical counterparts, who stood by and allowed massive bank failures. It remains to be seen, however, whether trade policymakers can do likewise. Thus far their efforts have been disappointing. We need decisive action: more meaningful commitments to avoid new discriminatory measures against foreign products and firms and a speedy end to the Doha Round.

Historians debate whether the Smoot-Hawley tariffs in the United States and the protectionist responses they engendered in other countries actually caused the Great Depression, but few dispute that the precipitous decline in global commerce that occurred between 1930 and 1933 made the depression worse. Efforts by the United States and its trading partners to bottle up demand at home with tariffs proved counterproductive because it led to a vicious circle of retaliation that in the end made everyone worse off.

Many countries are now simultaneously adopting programs of fiscal stimulus to offset the retrenchments in private consumption and investment. Since economies have become more open, some of the stimulus will inevitably leak abroad. The December 8 cover of BusinessWeek magazine raises questions about this and asks: "Can Obama Keep Those New Jobs at Home?" But it is far better to create a virtuous cycle in which countries prop each other up, than to repeat the experience in which they dragged each other down.

The world economy is better off today because it has established a multilateral system based on the rule of law that has bound tariffs for the most part at fairly low rates. It is unlikely therefore, that protection will take the overt form of raising average tariffs to sixty-percent levels. Nonetheless, as governments massively increase involvement in their domestic economies, their protectionism could take more subtle forms that could prove very damaging.

In many countries, large parts of the financial system are effectively being nationalized. Firms in other sectors are receiving government financial support. The temptation to adopt measures that discriminate against foreign firms and products in this context is very strong. As national policymakers take actions to bolster their domestic economies they need to be continuously reminded of the dangers of beggar-thy-neighbor policies. World Trade Organization (WTO) rules prohibit subsidies favoring domestic over imported output, but it will be extremely tempting for countries to confine their programs to domestically owned firms. The US Congress for example, is currently debating a plan to bail out the Big Three US automakers. What impact will such a plan have on foreign-owned auto companies in the United States and those that export autos to the United States? Similarly, there is currently uncertainty whether the tax breaks granted US-owned banks in the recent $700 billion bailout apply to foreign-owned banks that operate in the United States.

It is worrying that while the recent statement of G-20 leaders underscored the critical importance of "rejecting protectionism, and avoiding WTO-inconsistent measures to stimulate exports," there was no mention of avoiding discriminatory domestic subsidies. The G-20 should now extend their pledge of not raising new barriers to explicitly include new subsidies and procurement spending. And they should back up these pledges by establishing a WTO surveillance mechanism to which all members would report what measures they are taking.

While policymakers will be Closepreoccupied with restoring financial stability and renewing economic growth, they are also likely to undertake other policies, both domestically and through international agreements, to deal with climate change, terrorism, food safety, and food security. All of these are legitimate social concerns and in some cases, it may be necessary to adopt measures that impact trade. But as with domestic subsidies, the principle that intervention should adhere to the least trade-distorting approach should be adopted. Border taxes on carbon content and complicated certification schemes for imported biofuels are far less desirable, for example, than having all countries adopt binding commitments on climate change and sustainable practices. Similarly, ensuring food security through inventory policies and long-term supply commitments from exporters is far preferable to efforts to achieve self-sufficiency.

The other item for action is concluding the Doha Round. The current sense of urgency needs to be mobilized. Nothing would be more effective in underscoring global commitment to an open multilateral trading system than a speedy agreement that captures what is now on the table. One would have hoped our leaders would have realized all this. But the best the G-20 leaders could do recently was to retreat into bureaucratic jargon and instruct their trade ministers to "strive to reach agreement" on the Doha Round "modalities" by year end. Strive? Just modalities? That's pathetic. Why not instructions simply to reach agreement?

The leading developed (the United States and the European Union) and developing (India and China) countries must now bridge their differences for the greater good. The cost of failing to reach any agreement now outweighs additional marginal gains. The window of opportunity is closing rapidly and delay could prove fatal. As unemployment rises and commodity prices fall in response to slowing global demand, concluding an agreement to reduce trade barriers and cut farm subsidies will become increasingly difficult. The key is to act before a deep and possibly long-lasting recession sets in.

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