Philippe Legrain

The economics of the madhouse

The failures of global finance have brought the world economy to its knees, threatening a re-run of the Great Depression of the 1930s. Such a terrible outcome is much more likely if policymakers follow Ha-Joon Chang’s suggestion that the world needs a dose of protectionism to see it through these troubled times.

Around the world, we are witnessing the devastating impact of globalisation going into reverse. What was once a virtuous circle of rising trade and booming economic growth has become a vicious spiral of collapsing demand and plunging exports. The question is: how to break this spiral? The answer, in my view, is coordinated government action to boost global demand, combining large fiscal stimulus packages, unconventional monetary policy measures, and the nationalisation and restructuring of zombie banks that are dragging the economy down with them. Chang, in contrast, favours limited protectionism—in effect, a tax on imports.

This should ring alarm bells among people who may be tempted by the siren song of protectionism. Most governments are scrambling to boost spending and /cut/ taxes to stimulate demand. David Cameron’s Conservatives oppose such a fiscal stimulus. Chang goes one step further: he is proposing a (selective) tax hike instead. The immediate impact would be to reduce people’s purchasing power in a highly regressive way. And since Chang proposes that all governments agree to raise their import taxes, demand would be dealt a further knock by the fall in demand for our exports. Higher taxes and lower exports as a cure for the global recession? This is the economics of the madhouse.

Chang is surely aware of this. After all, even he concedes that an all-out trade war would be a bad thing. But the difference between limited protectionism and a trade war is a matter of degree: the former would involve fewer casualties, for sure, but it would not lead to economic resurrection. And history shows that limited protectionism is often a precursor to much larger conflicts.

Chang claims that rising protectionism in the 1930s was not as harmful as is often claimed. It is true that trade collapsed for several reasons, including falling demand. But protectionism greatly amplified the damage. According to a study by Jakob Madsen of Monash University (Trade Barriers and the Collapse of World Trade During the Great Depression), world trade declined 14% in inflation-adjusted terms between 1929 and 1932 due to declining incomes, 8% because of policy-induced tariff increases, 5% due to deflation-induced tariff increases (when prices are falling, a tariff of, say, £1 per item rises in real terms), and a further 6% because of the imposition of non-tariff barriers. So, most of the collapse in trade was due to rising protectionism rather than falling demand.

Nor did protectionism save jobs. Research by Doug Irwin of Dartmouth College, the leading US trade historian, concludes that “The Smoot-Hawley tariff of 1930, for example, significantly reduced imports but failed to create jobs overall because exports fell almost one-for-one with imports, resulting in employment losses in those industries.”

Clearly, then, the costs of protectionism are large. Yet Chang claims that “temporary” protectionism would have a big benefit: it would provide breathing space for companies and workers to reinvent themselves. But that too is dubious. Protectionism does not provide the right incentives for businesses and workers to adapt. Companies that have a captive local market tend to milk it, rather than seeking out more competitive markets overseas—especially if they are prevented from doing so by others’ protectionism. And while protectionism may start off as a “temporary” response to the crisis, companies that benefit from it have every incentive to find new reasons to maintain it, and to devote their energies to lobbying politicians to that end. Just look at Europe’s Common Agricultural Policy, which was originally designed to prevent Europeans starving. The last thing we need is a CAP writ-large.

Protectionism would obstruct the world economy from adjusting, rather than encouraging it. There is, for instance, huge overcapacity in the US and European car industries. If each country acts to prop up their carmakers, none will thrive. Only if the least efficient shrink can the carmarkers that produce the cars people actually want to buy thrive. Chang’s prescription is also bizarre considering his main focus is aiding developing countries. If the EU keeps out foreign cars, India’s Tata Motors and his native South Korea’s Hyundai, Daewoo and Kia will suffer.

In Britain’s case, advocating protectionism is particularly perverse. One big reason why the manufacturing sector has shrunk so much in recent years is the pound’s prolonged overvaluation. Now that the pound has collapsed, UK-based exporters, not least its remaining manufacturers, have received a timely boost that will make them more competitive when the global economy recovers. An increase in global protectionism would close off their future export markets.

The real help that companies need to tide them through the crisis is not protectionism but access to finance and broad measures to stimulate demand. These would also boost employment, especially if combined with cuts in payroll taxes and increased help for workers to retrain and find new jobs.

Inefficient markets

Peas in a Pod™
Fears that Apple aims to become the Microsoft of the music download business by using proprietary technology to lock in the dominance of iTunes have already attracted the scrutiny of Nordic competition watchdogs. So it is a worrying indication of Apple's monopolistic intentions that it is laying legal claim to the word "Pod," threatening to sue companies that use the word as part of their product names for infringing its iPod trademark. It is already taking action against the small start-up that makes the Profit Pod, an infrared scanner used to record activity on video-arcade machines.

But lest Steve Jobs forget, Apple did not invent the word "pod." By trying to appropriate it, he risks alienating millions of people who were once attracted to Apple's apparently upstart brand, as well as fanning the fears of European trustbusters. After all, even Microsoft has not dared to lay claim to the word "Word."

Inefficient markets

Doha derailed — who to blame?
So much for the lofty rhetoric about freeing trade and aiding development; when it came to the crunch, governments instead bowed to corporate protectionism. Thus the Doha round — launched after 9/11 as WTO members rallied around America in a show of unity — has collapsed in acrimony, with most blaming the US for its demise. This is not fair. America was guilty mainly of being too ambitious: it offered to prune its agricultural subsidies if others sheared their farm tariffs, but India and the EU refused.

Inefficient markets

Globalisation is working

Inefficient markets

Inefficient markets

Inefficient markets

It’s up to Lamy

Prospects for the Doha round look grim. Over five years in, and the World Trade Organisation’s 149 members still seem as far apart as they were during the 2003 Cancún debacle. Only the massaging down of expectations by WTO boss Pascal Lamy ahead of the Hong Kong summit last December rescued it from disaster. Now another deadline looms: 30th April, by when an outline deal must be reached if a final agreement is to be struck by the end of the year, ahead of the expiry of Bush’s fast-track authority in 2007. 

French myth-making

Many French people rejected the constitution because they regard Brussels as the handmaiden of "ultra-liberal" Anglo-Saxon capitalism, intent on deregulating markets and opening up the French economy to competition. Just look, they say, at the EU's proposed services directive, which would tear down barriers to trade in services, or at the eastward enlargement of the EU, which has exposed French workers to competition from low-wage, low-tax economies such as Poland. The upshot, they claim, is that the EU is driving social standards down and pushing unemployment up.

Free trade fallacy II

Eight years ago, in "The Next American Nation", Michael Lind terrified Americans with the threat of "ever-increasing low-wage, high-skill competition" from the third world, to which free-traders allegedly had "no answer." But after this menace failed to materialise, Lind changed his tune. Developing countries, far from being hypercompetitive are, in fact, unable to compete with rich countries, he now argues (Prospect, January 2003).

Listening banks

The protesters who make a habit of disrupting big international financial gatherings have wrought at least one desirable change. The sprawling annual meetings of the IMF and the World Bank have been slimmed down this September. But this gesture of modesty has not silenced the critics. The global financial establishment is under unprecedented attack-not just for the alleged harm it causes, but for its perceived lack of legitimacy.

Rich hypocrites

Oxfam is an antidote to claims that people do not care about politics any longer. They may not be enthused by traditional politics but they turn up in droves to Oxfam events. That is reason enough to pay attention to its new report on world trade rules, Rigged Rules and Double Standards. There is also merit in the charity's arguments. Oxfam says that free trade can benefit rich and poor countries alike, but claims that the rules that govern international trade are rigged in favour of the rich.

The not so global economy

When the World Trade Organisation last held a ministerial meeting, anti-globalisation riots made Seattle seem like a war-zone. Two years on, hapless WTO ministers are about to fly into a real war-zone. They plan to meet on November 9th in Doha, the capital of Qatar, the Gulf state that plays host to al-Jazeera, the Arab TV station that is scooping the world’s media with its coverage of the war in Afghanistan. The US and the EU insist the meeting should go ahead as scheduled, although an escalation of hostilities could yet derail it.

Against globaphobia

Perhaps the riots in Seattle marked a turning point for a globalising world. In the past 50 years cross-border trade and investment have boomed, raising living standards across the world and lifting millions out of poverty. But now a backlash against this closer integration has begun. This backlash is surprising. By and large, it comes not from developing countries which were battered when world financial markets seized up in 1997-98, but from rich countries which escaped largely unscathed. It is strongest in the US, the biggest beneficiary of free trade, luxuriating in an economic boom. And its main target is not multinational companies or global banks, but a once obscure regulator with 500 staff and an annual budget of £48m: the World Trade Organisation (WTO).