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01

Jun

2009

Trade Protectionism and Worldwide Economic Contraction
Monday, 01 June 2009 22:44
by Rodrigue Tremblay

“I almost went down on my knees to beg [President] Herbert Hoover to veto the asinine Hawley-Smoot Tariff.”...“That Act intensified nationalism all over the world.”
Thomas Lamont, banker and economic adviser, June 1930
"Now is a time where we have to be very careful about any signals of protectionism."
President Barack Obama, February 19, 2009
“From the purely economic point of view nothing speaks against free trade and everything against protectionism.”
Ludwig von Mises (1881-1973), Austrian economist

When the economy is booming, foreign borrowings and imports of goods and services from other countries are most welcome. They allow for more spending without inflation and they raise living standards. It is a version of having your cake and eating it too. In an economic downturn, however, the political reflex of populist politicians is to turn protectionist and to become economic isolationists by raising trade barriers. In such an environment, foreign competition becomes a convenient scapegoat for the crisis, even though the causes of such crisis are most often purely domestic in nature.

Regarding trade, the Obama administration seems to have adopted the “good cop, bad cop” routine, extolling the virtues of free trade in presidential speeches while letting Congress pass protectionist measures in series. The fear here is a repetition of the 1930s when American politicians rushed to pass the infamous Smoot-Hawley Tariff act of 1930 that triggered an international trade war and which accelerated the worldwide economic downturn. World trade plummeted into a spiral downward and domestic production for exports contracted everywhere. Normal trade links were disrupted and intricate inter-country production arrangements were dismantled.

Indeed, in a misguided attempt to fight the economic downturn, governments all over the world rushed to adopt self-destructive “beggar-thy-neighbor” policies, in a futile attempt to devalue each other's currencies and to reduce their imports in retaliation, forgetting that one country's imports are the other country's exports. The consequence was that from 1929 to 1933, the value of world trade contracted by two-thirds, going from $5.3 billion to $1.8 billion.

The world economy went down with world trade and every country was worst off as a consequence. A severe recession was then turned into a worldwide economic depression. This is because trade protectionism in the modern world is the equivalent of “cutting off your nose to spite your face” and its main consequences are to spread poverty and economic dislocations.


Some seventy years later, the same mistakes risk being repeated. Most modern economies are interrelated and if politicians begin to unravel such an economic integration, the consequences may be even worst than in the 1930s, because economic integration is much more advanced and prevalent than it was then.

World trade is already contracting due to the current global financial crisis, a decline in commercial bank trade credits and a drop in private investments. According to the World Bank's projections, total world trade in goods and services this year is expected to fall 6.1 percent. The decline will particularly hurt large export-led economies such as Mexico, Germany and Japan.

The issue of protectionism is also particularly important for Canada, the U.S.'s most important trade partner. The United States and Canada not only share this continent, but they also have a mutually beneficial trading relationship that has been enhanced with the signing of the Canada-U.S. Free Trade Agreement on October 12, 1987. This treaty was enlarged in 1994 to include Mexico with the implementation of the North American Free Trade Agreement (NAFTA). As a consequence, there are no tariffs on most goods that pass between Canada and the United States.

In 2008, Canada's trade with the United States accounted for about 76 percent of its total international exports and 63 percent of its imports, while U.S. exports to Canada represented about 20 percent of total American exports. A lot of American jobs are tied to American exports to Canada. In fact, Canada is the leading export market for 36 of the 50 U.S. States and Canada is a larger market for U.S. goods than all 27 countries of the European Community combined.

Moreover, Canada is the single largest exporter of total petroleum to the United States, supplying the U.S. with more than 2.5 million barrels per day. What is more, this oil supply is guaranteed under Nafta. There is also an important and growing cross-border trade of electricity between Canada and the United States that links the two economies.

This does not mean, however, that trade frictions between Canada and the United States do not exist. Sometimes politicians behave as if the trade agreement between the two countries did not exist. A case in point is the routine inclusion of “buy American” provisions in spending bills voted by the U.S. Congress, which can be considered overt protectionist trade-distorting measures and contrary to the spirit and the letter of the free trade agreement.

If the lessons of the past have been learned, governments should resist the temptation to export their economic problems abroad and should work instead to stimulate their economies without resorting to protectionist measures. What is needed now is to avoid sending the world economy into a self-reinforcing contraction that would hurt everyone.

Rodrigue Tremblay is professor emeritus of economics at the University of Montreal and can be reached at

rodrigue.tremblay@ yahoo.com.

He is the author of the book The New American Empire.

Visit his blog site at www.thenewamericanempire.com/blog.

Author's Website: www.thenewamericanempire.com/

Check out Dr. Tremblay's coming book

The Code for Global Ethics at:

www.TheCodeForGlobalEthics.com/

*****The French version of the book is now available.

See: www.LeCodePourUneEthiqueGlobale.com/

or: Le code pour une éthique globale

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James H. Murphy said:

0
In Defence of Protection
It is not surprising that Ludwig von Mises would say "nothing speaks against free trade and everything against protection." History is written by the winners and the history of protection has most definitely been written by free traders. And a poor job they have done. It would be more actuate to call it the myth of free trade and protection than history. Let me put forth the defense of protection that free traders seek to cover up and pretend does not exist.

Let me make it clear that I am looking at this from the standpoint of what is good for the United States and not any other country. I do not doubt that countries that have staked their economic well being on exports to the United States, at the expense of our jobs, risk getting slaughtered as United States turns to trade protection. The turn to trade protection is a matter of when not if. Real incomes here peaked in 1973 and are down since. It may be years away but trade protection is coming.

Let us start with Smoot-Hawley. To free traders Smoot-Hawley is the boogieman that is going to get you if you have protection. Free traders expect that you will accept their version of Smoot-Hawley which is that things would have been just fine had the United States not passed Smoot-Hawley. There are several problems with that version. The Depression was well underway when it was passed. At the time Thomas Lamont “almost went down on his knees” the United States was already the world’s most tariff protected economy and had been for more than a hundred years. Tariffs were high before Smoot-Hawley was passed and those tariffs were not the highest we have ever had. Smoot-Hawley tariffs became effective in 1931 and did not last long as FDR began reducing tariffs. When the Great Depression got worse in 1937 tariffs were back to their pre Smoot-Hawley levels. International trade was small at the time. It was only 6 percent of the GNP before Smoot-Hawley and was 2 percent after. Not a big enough decline to justify the free trader claims. The United States remained a net exporter during the Depression.

United States experience with tariff protection has been just the opposite of what free traders predict. According to free traders a trade protected economy without foreign competition should have high prices, shoddy products, and producers should have no incentive to innovate. Society should slide into mediocrity and poverty. The United States became a protected economy in 1828 after which innovation, quality, and wages went up while prices went down. In fact from 1828 until after World War II tariffs seldom went below 30 percent. From 1869 to 1900 GNP quadrupled while real wages increased 50 percent, and retail prices dropped significantly. Under free trade a century later real wages declined. If protection is bad how did the United States make the transition from a producer of raw materials and agricultural products in 1828 to an industrial power by the end of the century?


The theory of free trade is based on the Theory of Comparative Advantage developed by British economist David Ricardo. To really understand the theory some arithmetic is required but the non math version goes like this: Suppose England and Portugal have tariffs on wine and wheat. Consumers in both countries buy up local production and then imports if it is not enough. To buy imports the price is increased to include the tariff. Producers in both countries are protected from price competition from imports. Now suppose Portugal can produce wine at a lower cost than England can produce wine and visa versa for wheat. England could profitably sell wheat in Portugal at a price that would drive Portuguese wheat producers out of business. Portugal could profitably sell wine in England at a price that would drive English wine producers out of business. This does not happen because there is a tariff that increases the price to allow domestic production of both wine and wheat in both countries.

The free trade theory says eliminate the tariff. Let English wine producers and Portuguese wheat producers go out of business. Resources devoted to English wine production are switched to wheat production and Portuguese resources devoted to wheat production are switched to wine production. Because all producers are doing what they are best at total production will increase. Because of increased production all will live better. Society will benefit from increased productivity which will result in higher real wages.

What could possibly go wrong?

Assuming nobody is cheating three things:

1.Wine production exceeds market demand.
2.Wheat production exceeds market demand.
3.Wine and Wheat production exceeds market demand.


If any of these happen the workers of one or both countries are in a world of hurt. Unemployment is going to happen and wages are going to decline. Before free trade wine and wheat production both met market demand. There is no real reason to expect tariff elimination to increase demand to meet increased production capacity.

Today General Motors and Chrysler are in trouble because there is a world wide excess capacity to build cars and free trade allows foreign production into the United States.

Protection served the United States well. It produced the highs from which we have descended under free trade.
 
June 04, 2009
Votes: -1

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