World trade: it’s not the 1930s

Doug Irwin’s paper is published in a (free) VoxEU booklet “What World Leaders Must Do To Halt The Spread of Protectionism”, a collection of short essays that I’ve previously recommended. In summary, he observes:

  1. Countries today have many more policy instruments now for addressing economic crises. Draconian measures were needed to achieve internal stability when exchange rates were fixed (the ‘gold standard’) and monetary controls almost non-existent.
  2. In the early 1930s, countries imposed higher trade barriers unilaterally without violating any international agreements or anticipating much foreign reaction.
  3. Today, unlike the early 1930s, foreign investment has transformed the world economy; physical markets—like credit markets—are closely integrated and production is dispersed across international networks of goods and services supply chains, making simple border protection a less obvious ‘winner‘ for e.g. ‘saving jobs’.
  4. Unlike the early 1930s, the US—still the largest and most open economy— acknowledges its international responsibilities and is prepared to exercise its leadership to prevent an outbreak of protectionism. [At least, we hope so—PWG].

These differences in the policy environment and markets are a reason to be skeptical that the dramatic border protection of the 1930s will reappear. But that does not mean, of course, that governments will naturally adopt appropriate policies. There are still many other mistakes to be made (competitive subsidies and ‘buy-local’ policies in the name of fiscal ‘stimulus’ for example).

Still, there is one question now that is more or less the same as the questions posed in the 1930s: will trade agreements help to forestall these policy mistakes and encourage collaborative solutions? Or does our experience of the disappointments of Doha and the “essentially directionless” WTO discourage us from once again turning to the grand multilateral solutions that, eventually, allowed the legatees of the 1930s depression to guide the recovery of the world economy (albeit more than a decade later)?

Here’s a longer extract from Doug Irwin’s paper; but I encourage you to read the whole thing.

Countries today have many more policy instruments now for addressing economic crises. Governments then took no responsibility for propping up financial institutions and were unable to pursue reflationary monetary policies because of fixed exchange rates under the gold standard. In fact, those countries that remained longest on the gold standard also imposed the most draconian import restrictions (tariffs, quotas, and foreign exchange restrictions). They did so in an effort to reflate their economy and discourage imports from countries with depreciated currencies. Restrictive trade policies were at most a third-best or fourth-best policy for addressing economy-wide problems, but countries resorted to them because they lacked other macroeconomic policy instruments, mainly monetary policy, to stabilise the financial system and improve economic conditions.

In the early 1930s, countries imposed higher trade barriers unilaterally without violating any international agreements or anticipating much foreign reaction. Today, WTO agreements restrict the use of such discretionary trade policy by WTO members. And countries that are tempted to violate WTO agreements can have no illusion that they will avoid swift foreign retaliation if they choose to do so. If a country is certain that its exports will face new impediments abroad if it chooses to impose WTO-inconsistent import restrictions, it will think twice about restricting imports. However, this threat applies with the greatest force to developed nation WTO members, since the developing nation members have either not bound their tariffs or bound them at levels that are often far above the actual tariffs applied. As such, developing nations have plenty of room to raise protection without violating WTO commitments.

Unlike the early 1930s, foreign investment has transformed the world economy. Leading firms around the world have become so multinational in their production operations and supply chains that they have a vested interest in resisting protectionism. Many industries that faced import competition in the past — such as televisions, automobiles and semiconductors — have found that international diversification or joint ventures with foreign partners are a more profitable way of coping with global competition than simply stopping goods at the border. Moreover, many domestic industries no longer have much of an incentive to ask for import restrictions because foreign rivals now produce in the domestic market, eliminating the benefits of trade barriers for domestic firms. For example, unlike in the early 1980s, US automakers are not asking for trade protection because it would not solve any of their problems. They are diversified into other markets with equity stakes in foreign producers, and other foreign firms operate large production facilities in the US.

Unlike the early 1930s, the US accepts its international responsibilities and is prepared to exercise its leadership to prevent an outbreak of protectionism. The strong economic team of president-elect Barack Obama is likely to prevent the administration from imposing new trade barriers. These key factors distinguish the present era from the past. They have sustained political support for an open trading system and have prevented the outbreak of a globalisation backlash.

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