“Should We Fear a Trade Backlash?”

More and more I have been asked why we should allow immigration when there is so much domestic unemployment. It’s a hard question to answer, more so when you are talking to someone who is looking for a job and having a hard time finding one. Similarly, people ask why we should allow imports on the belief that restricting them would help with the domestic employment situation.

But one problem with protectionist measures is that they are like standing up to see better at a basketball game. If everyone is sitting down and you stand up, you will, of course, see better. You will be better off, so there will be a tendency to want to stand up, particularly during crucial parts of the game. But if everyone else stands up too, the result is different. Nobody can see any better than they could sitting down (on average), and they are less comfortable standing than they were sitting. All that happens as each person tries to stand up and improve their situation is that everyone is made, collectively, worse off. (I realize some people do prefer to stand – especially during the exciting periods of the game – but for the purposes of the example I’m assuming the the highest utility outcome is where everyone is sitting. If you don’t like this example, think of a crowded freeway and someone leaving for work early to beat the traffic. If that person is the only one to leave early, or one of the few, it works, but if everyone tries to leave early, you get the same old freeway problems but everyone had to get up earlier – so they are worse off.). Same with protectionism. If one country imposes protectionist measures by itself, the measures can be helpful and hence there is a tendency to do this, but when all countries follow suit and retaliate with their own set of trade restrictions, it makes everyone worse off.

Will governments repeat the “Smoot-Hawley-like backlash against trade” that occurred during the Great Depression? Barry Eichengreen says that could happen, but fortunately we’ve learned a thing or two since then. e.g. the value of fiscal policy, and hopefully that will keep the crowd under control:

Should we fear a trade backlash?, by Barry Eichengreen, Commentary, Project Syndicate: With more than a whiff of depression in the air, is a Smoot-Hawley-like backlash against trade about to follow? … The danger exists. … Other economic aspects of the 1930s that many of us thought we would never see in our lifetimes have reared their ugly heads. …

Some of these fears relate to the protectionist rhetoric of Barack Obama… Then there are the bailouts for General Motors and Chrysler. A subsidy for domestic auto producers is functionally equivalent to a tax on the US sales of foreign producers. Finally there is the fear that the US fiscal stimulus package … will be rendered less effective if the increased demand is allowed to leak out in the form of increased imports. US politicians will be quick to react with protectionist measures if they see that today’s spending programmes, which create a debt burden for future generations, fail to stimulate the American economy and only benefit other countries.

Fortunately there are reasons for thinking that this danger is overstated. First, the growth of multinational production and global supply chains has altered the political economy. Protecting US auto producers no longer automatically benefits US parts suppliers when the Big Three source many of their parts from Canada. Foreign companies with an interest in the maintenance of free and open trade are better represented in the political process than they were in the 1930s. …

Second, in 1930 Congress resorted to Smoot-Hawley out of desperation over its lack of alternatives. It was not that the Congress … resorted to a tariff to maximise the employment-creating impact from expansionary fiscal policies. Rather the tariff was imposed instead of expansionary fiscal policies, there as yet being no understanding of the case for fiscal stimulus. The danger of a tariff as a convoluted employment-creating policy is now less, precisely because we understand that there are direct ways for the government to stimulate demand, namely by cutting taxes and raising public spending.

Finally, if fiscal stimulus and the Fed’s zero interest rate policy mainly suck in imports, then the dollar will decline in response to the widening current account deficit. This will shift demand back toward domestic goods, venting the pressure for a protectionist response. This is no mere hypothetical: we have already seen the dollar falling in anticipation of just these developments. This is fundamentally different from 1930, when the US and other countries were on the gold standard and there was no scope for the exchange rate to adjust. …

Today, in contrast to the 1930s, our politicians have no shortage of policy levers. They just need to pull the right ones.

Originally published at the Economist’s View reproduced here with the author’s permission.